The Best Kept Secret in Real Estate
This month let’s introduce you to the IRC 1031 Tax Deferred Exchange. This Federal Tax Law is used everyday by savvy investors throughout the United States. These investors save thousands, tens of thousands and in the case of some of our clients, millions of dollars each year in deferred capital gains taxes. That means that YOU control YOUR money, which you can then use to increase your real estate investments. These principals apply to investors no matter what the size of your investment property portfolio. Whether you own a single-family rental home, an owner occupied duplex or a 400 unit commercial property, this 100% tax deferral program is designed for your benefit. What this strategy allows is for you as the investor to sell an investment property and roll the proceeds of that sale into another property of “Like Kind” and avoid paying a capital gains tax penalty. The term “Like Kind” will be defined a little later. As a 1031 Exchanger there are certain criteria that you must meet in order to perform an exchange. Now let’s outline these criteria and further define the IRC 1031 Exchange process
Tax deferred exchanges are found in Section 1031 of the Internal Revenue Code. They have been on the books since 1921. New Treasury regulations in 1991 describe the steps to perform an exchange.
Property being held for income or business use or, in the case of bare land, held as a long-term investment, qualifies for a 1031 exchange. The so-called “like kind” requirement is very broad. One can go from rental houses to an office building, a retail building to an apartment; or a vacant lot to a vacation rental. An investor can exchange several properties for one, or sell one and buy several. Also, the rental portion of an owner-occupied multi-family, is subject to capital gains taxes, but can also be used in a tax-deferred exchange.
To be entirely “tax deferred” the investor should buy replacement property that is equal or greater in value as the price of the property sold. Also, the investor has to use all of the cash proceeds from the sale (the equity) to purchase the replacement property. It is possible to purchase a replacement property of lesser value during an exchange, but be aware that any monies remaining may be subject to a capital gains tax.
The essence of the tax-deferred exchange is that the taxpayer seeking to do an exchange (the Exchanger) does not take possession or have control of the sale proceeds
To start, the Exchanger has a property to sell. Prior to the close of the sale, the exchanger and a 1031 Qualified Intermediary enter into an “exchange agreement” and the sale proceeds are sent to the Intermediary and put into an escrow account. It is REQUIRED that the Intermediary be in place with the exchange agreement before the sale closes. A 1031 Exchange cannot be performed if the Intermediary is not put in place BEFORE a sale takes place.
When the sale closes, the buyer takes title to the property. Hopefully the Exchanger has been out shopping for replacement property and has something to purchase in the near future. There are, however, strict time limits. From the date of the closing of the sale, the Exchanger has 45 days to “identify” potential replacement properties and a total of 180 days to acquire the replacement property, or the due date of the tax returns, whichever comes first.
By allowing investors to reinvest all of their equity from their sales, tax-deferred exchanges can help build wealth and achieve investment goals. With a little planning and sound professional advice, any investor can use the tax rules for their long-term benefit.
This information has been provided courtesy of HB Buckner of Wealth Exchange Solutions, formerly division manager of Asset Preservation, qualified IRC 1031 Intermediaries.
