Traditional Exchanges What are the tax advantages in a 1031 exchange?
You can defer the payment of capital gains taxes associated with real estate transactions. By selling one property and buying a higher-priced property, you can also get additional depreciation deductions, which can act to increase your after-tax income. In addition, you can eliminate paying taxes on the recapture of depreciation you've taken on the property. Can I use my primary residence or second home in for a 1031 exchange?
No, only real estate property held for business or investment purposes can be used in a 1031 exchange, and both properties in the transaction must be of "like kind". What is meant by "like-kind" property in a 1031 exchange?
Like kind property is real estate or other tangible property that is similar in nature, characteristics, or SIC classification in a 1031 exchange. Whether two properties are of "like kind" can also be dependent on state law. Can I sell or buy multiple properties in a 1031 exchange?
Yes, you can exchange multiple smaller properties for a larger one and vice versa. The key is always trade up in value in order to maximize the amount of capital gains taxes that are deferred. Are their time restrictions on a 1031 exchange transaction?
Yes, there is a 180-day time span in which the 1031 exchange must take place. During this period there is also a 45-day period where the exchanger must identify which replacement property will be purchased. How can I defer the maximum amount of capital gains tax in a 1031 exchange?
The main rule is that the replacement property being purchased must be equal or greater in value to the relinquished property being sold. The net effect must be that the entire net proceeds from the sale must be used to purchase the replacement property. Does one receive cost basis for the replacement property?
No, cost basis from the relinquished property is carried forward to the replacement property in a 1031 exchange. This is one drawback and is often overlooked or misunderstood. What is a Qualified Intermediary and must I use one in a 1031 exchange?
The Qualified Intermediary (QI), also called an accomodator, is a third-party that facilitates the transaction and is required by the IRS to qualify a 1031 tax exchange. The IRS does not allow your accountant, attorney, or escrow company to act as the QI. Can I do multiple 1031 exchanges and avoid paying taxes altogether?
Yes, by continuing to sell and buy like-kind properties and following 1031 exchange rules, your estate when you die can avoid paying capital gains taxes.
Reverse Exchanges Under Section 1031, a taxpayer may defer capital gains taxes by exchanging property (“relinquished property or RQ”) for like-kind property of equal or greater value (“replacement property or RP”). In phase one of a forward exchange, a Qualified Intermediary (“QI”), on behalf of the taxpayer, sells the RQ. In phase two, the QI uses the proceeds to acquire one or more RPs identified by the taxpayer. The RP purchase must occur within 180 days after the sale of the RQ. What happens if the taxpayer can’t complete his RQ sale, but must acquire
his intended RP because he doesn’t want to lose the property or is under contract to complete the purchase? Can he complete a 1031 exchange? Yes.
The taxpayer can still obtain the benefits of section 1031 by utilizing a reverse exchange. A reverse exchange is subject to the same rules and regulations as a forward exchange, except that it requires the use of an exchange accommodation titleholder (“EAT”) and is subject to some additional rules specified in Revenue Procedure 2000-37.
In a reverse exchange, the QI must utilize an EAT—a third party—typically an affiliate of the QI. The EAT purchases the RQ, which allows the taxpayer to immediately complete an exchange (“exchange first” or “hold relinquished”). Alternatively, the transaction may be structured so that the EAT purchases the RP and holds it until the taxpayer locates a buyer and can then complete an exchange (“exchange last” or “hold replacement”). Exchange First: The Mechanics
The taxpayer loans funds to the EAT to purchase the RQ. The purchase price is estimated by the taxpayer or is based on a pending purchase agreement—if there is one at the time. The EAT purchases the RQ from the taxpayer (any liens and encumbrances remain in place). The QI, as in a forward exchange, acts as the seller, receives the proceeds and then uses the proceeds to acquire the RP. At this point, the taxpayer has completed the exchange of the RQ for the RP, but the EAT remains on title to the RQ. However, to successfully complete the reverse exchange, the EAT must sell the RQ to a buyer within 180 days. If the EAT completes this final step, it will use the proceeds to repay the loan it originally obtained from the taxpayer to first acquire the RQ (note that the taxpayer is responsible for locating a buyer and negotiating the terms of sale between that buyer and the EAT). The 180-day exchange period commences on the date the EAT acquires the RP. Exchange Last: The Mechanics
The taxpayer loans funds to the EAT to purchase the RP. The EAT purchases the RP and holds it until the taxpayer finds a buyer for the RQ and is ready to complete a forward exchange. After the taxpayer locates a buyer for the RQ, the QI, as in a forward exchange, sells the RQ, receives the proceeds and then uses the proceeds to acquire the RP from the EAT. The QI will cause the EAT to convey title direct to the taxpayer. The EAT will then use the proceeds to repay the loan it originally obtained from the taxpayer to first acquire the RP. The taxpayer has only 180 days to sell the RQ and acquire the RP from the EAT. The 180-day exchange period commences on the date the EAT acquires the RP. The reverse exchange is a valuable tool for those taxpayers who must complete the acquisition of their replacement property before they are able to complete the sale of their relinquished property |
