| Under Section 1031 of the Internal Revenue Code, owners
of real estate held for investment or use in a trade or
business can swap their property tax-free for "like-kind"
real estate. Exchanges are made for people wanting to stay
invested in real estate, increase their leverage and to
avoid paying hefty taxes upon the sale of property. Like
Kind
- Apartments
- Rental Houses
- Retail Properties
- Commercial
- Raw Land
- Office Buildings
- Industrial
- Ranches
Non Qualifying Properties
- Personal Residences
- Dealer Property
- Partnership Interests
- Inventory
Reason to Exchanges
- Restoring Depreciation that will soon expire - by
exchanging one property for another of greater value.
- To upgrade size and/or quality of investment. An
exchange can be utilized to combine the equity of one or
more properties into a larger singular investment.
- To change investment location. An exchange can be
executed in anticipation of market trends to maximize
appreciation potential.
7 Steps for a Successful
1031 Tax Deferred Exchange
Step 1: Consult with your tax and financial advisors to
determine if a tax deferred exchange is appropriate for your
circumstances and compatible with your investment goals.
Step 2: Listing the Relinquished Property for sale with a
licensed real estate broker. During the first step the
Exchanger will list the Relinquished Property with a real
estate broker. The broker/agent will disclose the intent to
complete an exchange in the listing agreement.
Step 3: Offer, Counter Offer and Acceptance. The
Exchanger enters into a contract with the Buyer for the
sale/exchange of the Relinquished Property. The broker/agent
discloses the Seller/Exchanger's intent to exchange into the
Purchase Agreement and Receipt for Deposit.
Step 4: Open escrow for the Relinquished Property and
coordinate with the Facilitator. The Facilitator prepares
the exchange agreement and coordinates with the escrow
holder to close escrow as Phase I of a tax deferred
exchange. Important: The exchange agreement must be in place
and signed by all parties prior to close of escrow.
Additionally, all earnest money deposits should be placed
with the title company.
Step 5: Replacement Property Identification. After
closing escrow for the sale of the Relinquished Property,
the Exchanger must identify all Replacement Property within
45 days from day after close of escrow.
Step 6: Contracting for the Replacement Property. After
closing on the Relinquished Property the Exchanger has 180
days to acquire the Replacement Property. With the help of
his or her agent the Exchanger enters into contract to
purchase the Replacement Property from the Seller. In the
contract to purchase the agent discloses the Exchanger's
intent to complete the exchange and obtains the Seller's
cooperation.
Step 7: Open escrow for the Replacement Property. The
Facilitator prepares the Phase II Exchange Agreement and
coordinates with the Replacement Property Escrow holder. The
funds held in trust by the Facilitator are placed in escrow
and the Replacement Property is purchased by the Facilitator
from the seller. The Facilitator then transfers the
Replacement Property to the Exchanger and the transaction is
closed as Phase II of a delayed exchange.
Identification of Replacement Property
Regardless of the number of relinquished properties
transferred by the Exchanger as part of the same exchange,
the maximum number of replacement properties that the
Exchanger can identify is as follows:
3 Property Rule: Three properties without regard to the
fair market values of the replacement properties.
Or
200 Percent Rule: Any number of properties as long as
their aggregate fair market value as of the end of the
identification period does not exceed 200 percent of the
aggregate fair market value of all the relinquished
properties as of the date the relinquished properties were
transferred by the Exchanger.
Exception
95 Percent Rule: Any number of replacement properties
identified before the end of the identification period and
received before the end of the exchange period, but only if
the Exchanger receives before the end of the exchange period
identified replacement property the fair market value of
which is at least 95 percent of the aggregate fair market
value of all identified replacement properties.
Glossary of Terms
Accommodator: A principal involved in the exchange
transaction who agrees to assist the exchanger to effect a
tax-deferred exchange. Same as Facilitator or intermediary.
Accommodating Party: In an exchange of properties there
is always a person or entity that steps in to accommodate or
facilitate the exchange transaction. Depending on how the
transaction is structured, the accommodating party may incur
additional liability in their efforts to assist in the
exchange.
Acquisition Property: Replacement property
Actual Receipt: When the Exchanger actually receives the
funds from the sale of the Relinquished Property. Receipt of
cash by the Exchanger before he receives the Replacement
Property may be enough to destroy the tax deferred treatment
of the transaction.
Adjusted Basis: Generally speaking the adjusted basis is
equal to the purchase price plus capital improvements less
depreciation. Transactions involving exchanges, gifts,
probates and receiving property from a trust can have an
impact on calculating the property's adjusted basis. The
taxpayer's C.P.A. or tax advisor is the party to look to for
these types of questions.
Boot: Boot is any type of property received or given up
in an exchange that does not meet the like kind requirement.
Generally speaking, receiving boot will trigger the
recognition of gain and taxes. If the Exchanger receives
boot, they will be taxed. Boot added or given up by the
Exchanger does not necessarily trigger a taxable event. In a
real property exchange, boot received is any type of
property received by the exchange which is not real property
held for investment or productive use in a trade or
business.
Cash Boot: Cash Boot consists of cash and nonqualifying
property. A car, a boat or receipt of the beneficial
interest in a promissory note are all examples of Cash Boot.
Mortgage Boot: Mortgage Boot consists of the secured debt
given up and received as part of the same exchange. If the
exchanger increases the amount of debt on the Replacement
Property verses the Relinquished Property, they have given
mortgage boot. If the exchanger decreases the amount of debt
on the Replacement Property verses the Relinquished
Property, they have received mortgage boot. Generally
speaking, mortgage boot received triggers the recognition of
gain and it is taxable, unless offset by Cash Boot added or
given up in the exchange.
Constructive Receipt: Even if the Exchanger does not
actually receive the proceeds from the disposition of the
Relinquished Property, the exchange will be disallowed if
the Exchanger is treated as having constructively received
the funds.
Delayed Exchange: Also called non-simultaneous, deferred
and Starker. A delayed exchange is a tax deferred exchange
where the Replacement Property is Received after the
transfer of the Relinquished Property. In a delayed exchange
the Exchanger must identify all potential Replacement
Properties within 45 days from the transfer of the
Relinquished Property and the Exchanger must Receive all
Replacement Properties within 180 days or the due date of
the Exchanger's tax return whichever occurs first.
Like-Kind Property: Refers to the nature of the property
the Exchanger gives up or receives as part of the same tax
deferred exchange transaction. In order to qualify as like
kind the property given up or received must be held for
productive use in a trade or business or held for investment
to qualify as like-kind.
Realized Gain: Refers to a gain that is not necessarily
taxed. In a successful exchange the gain is realized but not
recognized and therefore not taxed.
Recognized Gain: Refers to gain which is subject to tax.
When someone disposes of property at a gain or profit in a
taxable transfer such as a sale, the gain is not only
realized, but recognized and subject to tax.
Relinquished Property: The property given up by the
exchange to start the 1031 exchange transaction. This
property usually passes through an accommodator before
transferring to the ultimate Buyer.
Reverse Exchange: An exchange where the Exchange acquires
or gains control of the Replacement Property before
disposing of the Relinquished Property.
Simultaneous Exchange: Also referred to as a concurrent
exchange. A simultaneous exchange is an exchange transaction
where the Exchanger transfers out of the Relinquished
Property and Receives the Replacement Property at the same
time.
Transfer Tax: A tax usually assessed by a city or county
on the transfer of property. It may be based on equity or
value. When structuring a multi-party exchange an exchange
agreement will usually call for direct deeding to eliminate
additional transfer tax.
April 15th
A taxpayer must identify replacement property within 45
days after the transfer of the relinquished property, and
acquire the replacement property within the earlier of 180
days of the relinquished property closing, or the due date
of the taxpayer's tax return. This means that 1031 escrows
that close after Oct. 18 will not have the full 180 days to
acquire the replacement property unless the taxpayer files
an extension.
Contact your CPA or tax attorney for advise.
By Neda Dabestani-Ryba
Prudential Carruthers REALTORS
Neda Dabestani-Ryba is a licensed Realtor in Maryland.
She is a member of the President's Circle of Top Real Estate
Professionals. She can be reached at (800) 536-3806 or visit
her website for more information:
http://neda.dabestani.pcragent.com/ Prudential
Carruthers REALTORS is an independently owned and operated
member of Prudential Real Estate Affiliates, Inc., a
Prudential Financial company. Equal Housing Opportunity
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