Are you a real estate investor? If you have property to sell and want to reinvest in another property you may want to consider utilizing the IRS approved 1031 Exchange (sometimes called a “like-kind” exchange).
Benefits of a 1031 Exchange
- Deferred capital gains taxes
- Greater potential cash flows
- Money saved from zero capital gains taxes calculated on your old investment property means more money to reinvest in a newer, more profitable investment property.
Anytime a 1031 Exchange is used, we recommend that in addition to your real estate agent you are also consulting with your real estate attorney and personal tax adviser. Below are some points to consider, but in no way should you consider this to be legal or tax advice, it is simply posted here for informational reading purposes only.
- How Does a 1031 Exchange – sometimes called a like kind exchange work?
- Is it possible to purchase a replacement property before I sell the property that I own?
- What is a Qualified Intermediary?
Provision 1031 of the U.S. Income Tax Code allows owners of investment property, be it commercial, industrial, residential real estate, or vacant land, to sell that property and defer capital gains taxes by exchanging the proceeds, through an intermediary, for an investment in another qualifying property or group of qualifying properties.
Recent changes to the tax code have eased restrictions regarding “like-kind” property and now allow properties of different kinds to also be exchanged under Provision 1031.
(This is an important point.) To affect an exchange, the seller places all sale proceeds into a special trust account designated for this purpose. These trust accounts are normally maintained by banks, trust companies or other financial institutions. They are often referred to as a”3rd party facilitator”.
Sellers have a maximum of 180 calendar days from the closing of the initial sale to complete the exchange. Within the first 45 days of this period a seller must designate candidate properties and properly identify them.
A seller may target up to three properties regardless of value or a group of properties with a combined value that does not exceed 200 percent of the value of the initial property sale. The funds in a trust account can be used as earnest money for designated property once all IRS requirements for a 1031 transaction are met.
If no new properties are identified in the first 45 days, or no designated transaction is completed during the full 180 day period, the trust will be disbursed and the proceeds will be returned to the investor and will be taxed at the prevailing capital gains rate.
(This is an important point.) If you are considering a real estate transaction that will utilize the 1031 Exchange concept, it is important to make this decision PRIOR to the actual close of escrow of the property you will be selling as part of the exchange.
We can put you in touch with the needed “3rd party”, and work with you to assist in the listing and sale of the property you will be selling, and also thru the selection of the new property you will be acquiring.
Yes, this is known as a “reverse exchange.” In a reverse 1031 exchange, the replacement property is acquired before the relinquished property is sold. Although the paperwork involved in a reverse exchanges is more complex than that of a standard 1031 exchange, the concepts are similar.
Within 5 days of the Qualified Intermediary taking title to the replacement property, the taxpayer will execute an agreement with their Qualified Intermediary which details the taxpayer’s intention to meet IRS requirements regarding safe harbor reverse exchanges.
The Qualified Intermediary holds title to the replacement property for up to 180 days. During that period, title to the relinquished property must be transferred and the title to the replacement property taken by the taxpayer. The property to be relinquished must be identified in writing within 45 days from the date the Qualified Intermediary assumes the title to the replacement property.
The Qualified Intermediary (or Accommodator) is a corporation or individual that facilitates 1031 exchanges. The Qualified Intermediary does not provide legal or specific tax advice to the exchanger, but performs the following services:
- Coordinates with the exchangers and their advisers, to structure a successful exchange.
- Prepares the documentation for the Relinquished Property and the Replacement Property.
- Furnishes escrow with instructions and documents to effect the exchange.
- Secures the funds in an insured bank account until the exchange is completed.
- Provides documents to transfer Replacement Property to the exchanger, and disburse exchange proceeds to escrow.
- Holds the document of Identification of Replacement Properties sent by the Taxpayer.
- Submits a full accounting of the Exchange Funds for the Taxpayers Records.
- Submits a 1099 to the Taxpayer and the IRS for any growth proceeds paid.
Anyone related to the taxpayer, or who has had a financial relationship with them within the two years prior to the 1031 exchange can not be used as the Qualified Intermediary. Taxpayers cannot use their attorney, certified public accountant or real estate agent as a Qualified Intermediary.