DESCRIPTION OF 1031 EXCHANGE © 2005 - 2007

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  • Do you own investment property or income producing property?
  • Do you intend on selling investment property within the near future?
  • Are you looking to defer gains or losses on the sale of investment property?
  • This type of transaction may be a candidate for a 1031 Exchange!
  • Would you be willing to exchange said existing property for property of "like kind"?
  • Defer capital gains taxes and thus keep those funds working for you or your business?

Section 1031(a) allows taxpayers to structure deferred like-kind exchanges, it provides that no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of like kind that is to be held either for productive use in a trade or business or for investment.

Under Section 1031(a), property may be treated as like-kind property if it is:

(1) identified as property to be received in the exchange (replacement property) on or before the day that is 45 days after the date on which the taxpayer transfers the property relinquished in the exchange (relinquished property). i.e within forty-five calendar days from the date of closing on the relinquished property, the taxpayer provides notice to the intermediary of the identity of the replacement property, i.e. you have 45 days from the closing of your sale to list the properties you may want to buy.

(2) received before the earlier of the date that is 180 days after the date on which the taxpayer transfers the relinquished property, or the due date (determined with regard to extensions) for the transferor’s federal income tax return for the taxable year in which the transfer of the relinquished property occurs, i.e. from the sale closing date, you have 180 days to close on the purchase of one or more properties from the 45-day list.

Other Requirements:

Real Property Use. Both your old and new properties must qualify as investment or business use. If both properties pass this test, you can exchange nearly any type of real estate.

Qualified Intermediary (QI). The IRS mandates that you use a QI to prepare the legal documents for your exchange. Because the QI must be independent, it cannot be your friend, employee, broker, or even your accountant or attorney. The QI also holds your money, so that you do not have access to it. Click here for a further definition of a Qualified Intermediary (QI).

Proper title holding. You must purchase and take title to your new property exactly as you held title to your old property.

Reinvestment Requirement. To defer all of your capital gain tax, you must buy a property equal or higher in value than the one you sold. Also, you must reinvest all of the cash proceeds from your sale.

Selecting a QI:

Security of Funds. Funds should be bonded and QI should have professional liability insurance.

Technical Expertise. Must be knowledgeable and experienced.

The real estate purchase and sale agreement should include an Exchange Cooperation Clause.

Property held for personal use will prevent a property from qualifying for a 1031 Exchange. However a multifamily property in which a percentage of the property is used for personal use and the remainder used for business purposes may be treated as two separate transactions and thus that portion of the property used for business purposes may qualify for a 1031 Exchange.

Parking transactions typically are designed to “park” the desired replacement property with an accommodation party until such time as the taxpayer arranges for the transfer of the relinquished property to the ultimate transferee in a simultaneous or deferred exchange. Rev. Proc. 2000-37 provides procedures for qualifying parking transactions as like-kind exchanges in situations in which the taxpayer has a genuine intent to accomplish a like-kind exchange at the time that the taxpayer arranges for the acquisition of the replacement property and actually accomplishes the exchange within a short time thereafter.

IRC 1031, Like Kind Exchanges involve business or investment property which is exchanged for like kind property.  Like Kind Exchanges must not involve constructive receipt of cash for the property relinquished.  The use of a qualified intermediary can facilitate the exchange using escrow accounts.  This type of intermediary promises to return the proceeds of the exchange to the transferor of the property.  The proceeds are used to purchase replacement property of like kind.  Real or personal property must be replaced with real or personal property of the same asset class to defer the gain. 

The taxpayer negotiates a purchase contract for the replacement property and assigns its rights under the purchase contract to the intermediary; the intermediary accepts the assignment; the other party to the contract is notified of the assignment.

The Exchanger and the Qualified Intermediary enter into an Exchange Agreement. This agreement requires that the QI acquire the property from the E and transfer it to the buyer by direct deed from the E and the QI acquirer the replacement property from the seller and transfer it to the E by direct deed from the seller. The cash from the relinquished property are assigned to the QI and are held by the QI in a seperate account. The funds are used by the QI to purchase the replacement property for E.

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