Tax Information: 1031 Tax-Deferred Exchange
No Gain, No Pain!
Everyone is talking about 1031 Exchanges these days. As rightly they should! The Section 1031 Tax-deferred Exchange is the most powerful investment tool available to the U.S. Taxpayer for Wealth Building and Estate Planning! As our Resort Real Estate market has matured and gained momentum over the last five years, many owners have found themselves faced with considerable, even dramatic capital gains exposure. With Federal tax at 28% and State at 5% you can easily be paying out a Third of every Dollar that's in your real estate!
The Section 1031 Exchange gives you the ability to move equity (anywhere in the US) into a more desirable property without triggering (recognizing and paying) capital gains until a future date. This deferral of Capital Gains (at whatever rate they are) allows you to convert what would have been tax dollars INTO investment dollars, and results in what is virtually an interest-free loan from Uncle Sam! This unequalled Estate Building tool allows you to Increase your Buying Power, and to pick the year for you to realize your capital gains.
The 1031 Exchange has become a hugely important strategy for resort real Estate investors and owners. Fully one in three of our real estate transactions in recent years has involved a 1031 Tax deferred Exchange on either the buyer or seller's side. Remarkably, most of them have been owners who have traded back into another property here in the Breckenridge area: into a newer or larger property, from a condo to a home, from vacant land into a condominium. Others are selling their depreciated rental property back home and converting them into holdings here in the Kingdom of Breckenridge. Whatever the reason, you want to make sure you have a valid exchange when done!
You can call anything you want an exchange, but if the IRS determines later that the form and substance of the exchange were not structured correctly, the IRS can disallow the exchange and them WHAM! You get to realize the capital gains, PLUS penalties, PLUS interest back to the year when it was due! Section 1031 of the Tax Code is unique in that it is the Structure, not the Intent that determines a successful exchange. You should make sure you have the involvement of a Qualified Intermediary (Exchange Accommodator). Of course you should consult with your Tax Advisor, accountant or attorney to determine if an Exchange is right for you, but NOTE that they cannot perform the exchange for you! (They are Dis-qualified Persons).
MAKE THE TAX LAWS WORK FOR YOU! See why the 1031 Exchange is one of the most powerful wealth building tools in America.
|1031 Exchange Experts||Asset Preservation, Inc.|
|Ten Mile Exchange Services, Inc||Land Title Exchange Corp|
Ten Common Questions About 1031 Exchanges
1. What does an Exchange Accommodator (Qualified Intermediary) do?
The Qualified Intermediary and the Exchange Accommodator are the same thing. They act as a safe harbor approved by the IRS to hold the exchange proceeds and to make sure that the structure of the exchange is properly observed. Note that there are many persons who are Disqualified by the IRS to act as Accommodator: your attorney, your accountant, your broker, investment banker, or a relative cannot perform the Exchange for you.
The Accommodator does more than just hold the money to avoid constructive receipt, they actually create the mechanism for a trade. In the case of a Reverse or Improvement Exchange, they provide a safe harbor for the title of the replacement property to be parked until the exchange is completed.
2. What is the timing of the sale and acquisition of my new property?
You have up to 45 days after the sale of the Relinquished Property to choose your Replacement Property. The Replacement Property MUST be one selected during that period. You have no more than 180 days to close on the Replacement Property, OR the next due date, including extensions, of the tax return for the year in which the exchange occurred, whichever is EARLIER.
For example, any exchange initiated after October 17, you will have LESS than 180 days unless you file the proper extension with IRS. Christmas and Sundays count!!
3. What is Identification and when do I do it?
To qualify for a Sec. 1031 tax deferred exchange, the tax code requires that the Replacement Property be identified during a strictly observed time period. The Identification period begins when you transfer the Relinquished Property (the one you parted with), and ends at midnight of the 45th day. Do not be caught by the clock-- Christmas and Sundays count!
You can select several (or multiple) properties, and even change your mind about your choices during the period. However, you may ONLY acquire a property that was identified during the 45-day period, not after.
The Exchanger (you) is required to specify the property (or properties) clearly with legal description, address, unit number or name:
*In a written document signed by Exchanger
*Hand delivered, faxed or mailed
*Before midnight on the 45th day
*To the person responsible for transferring the new replacement property to you (generally the Qualified Intermediary), or any other person involved in the exchange other than you or any Disqualified Person.
4. What if somebody else buys my Identified Property?
So, your 45 days have passed and you properly identified your three properties; you wrote them down and mailed them off all timely and everything, and then you come to find out that somebody else &#%!! has put in a contract, and that one, or more of them are sold. Ouch! You can only acquire one of the properties identified during the period. However, identifying on paper is one thing that the Exchanger does to take decisive steps towards having a contract on your Replacement Property, so that the ticking clock does not make your decisions for you.
5. Can I trade my vacant land for a condo?
If both are held for investment or the production of income, yes. Or, you can trade a parking lot for an apartment building. The manner in which the property is held or used will determine if it is like-kind in the eyes of the IRS and suitable for exchange.
6. Can I trade my second home?
To qualify for a tax-deferred exchange, the property must have been held for investment or the production of income. Typically your second home will not qualify for this treatment. Have you rented the property out? How have you treated the property on previous years' tax returns? There are specific strategies for converting the use of a property into one appropriate for exchange (Conversion). Again, this is where you need the assistance of an experienced Exchange Accommodator to properly position your asset.
7. What if the one I want is under construction and not complete?
The Reverse Exchange may be combined with an Improvement Exchange to allow for construction improvements to be included in the exchange, which may be supervised or managed by the Exchanger, however, the 180-day time limit will still apply. The exchange for the Replacement Property must be completed during the 180 day period. You need to make sure that your contemplated property will be completed and ready to close. Count your days carefully!
8. Can I trade my condo in the Caymans?
Sorry! Properties outside the U.S. or its possessions are not like-kind and cannot be exchanged. Try St. Thomas instead!
9. What is BOOT?
Boot is a non-like-kind property received in an exchange (such as cash) and is a taxable event. Boot is when the IRS says you received extra money in the exchange. There are many ways to trigger this recognized gain besides getting a pile of cash! Debt Relief (of a mortgage on the Relinquished Property) will be treated as Boot (or cash received) unless it is offset by new debt on the Replacement property.
Rule of Thumb for 100% Tax-Deferral:
- Trade even or up in value
- Trade even or up in equity
- Trade even or up in Debt
- AND USE ALL THE PROCEEDS
10. Why can't I just leave the money in an escrow account and not touch it?
If you have direct control over the disposition of the exchange funds during the 180-day period (escrow instructions, for example, or deciding when to release escrowed funds), the IRS figures that you received the money in a sale, and then made a subsequent repurchase. No Exchange! This is called Constructive Receipt and is a fancy way of the IRS saying, you got the money, and it triggers all of the gain, plus potential penalties and interest. The proper paper trail with the Exchange Accommodator is essential for documenting where the money went and who holds it.
Everything You've Ever Wanted to Know about 1031 Exchanges
Remember, always check with your CPA or tax attorney before you do anything!
If you are interested in learning more about 1031 Tax-Deferred Exchanges, I would be happy to assist. Please don't hesitate to contact Andrew for more information, or call (970) 547-7751 for your real estate enquiries.