1031 TAX DEFERRAL STRATEGIES
For Real Property Investors, Internal Revenue Code Section 1031 is a powerful tool for deferring capital gains tax on commercial/investment transactions. This Section allows taxpayers to exchange real or personal property for new "like-kind" property, while deferring recognition of any capital gains. Section 1031 creates the ability for sellers to defer capital gains on investment property by placing the sale proceeds with a "Qualified Intermediary" for up to 180 days until the closing of the purchase of the replacement property.
GROWTH STRATEGIES
For real estate professionals, 1031 Tax Deferral is a marketing tool like none other. 1031 gives you a reason to reach out to your clients and potential clients, and gives them a win-win message. By partnering with Bayview Financial Exchange Services as Qualified Intermediary, you offer your clients the fast, secure and exceptional service which will keep them coming back. Use the FAQ center here to learn more about identifying potential 1031 transactions. Call us today with your questions at 1-800-845-2055.
STEPS IN THE 1031 TAX EXCHANGE PROCESS
Tax Deferral Under § 1031:
The most commonly used tax-deferral strategy is the Forward Delayed Exchange. In a typical Delayed Exchange, the taxpayer sells a business or investment property and acquires replacement property of equal or greater value within 180 days. The use of a Qualified Intermediary is required to facilitate a valid tax-deferred exchange.
Before you begin the exchange process, be sure to consult with your tax or financial advisor to insure that a 1031 exchange is right for you. Then, contact a Qualified Intermediary to help you complete the exchange process in three easy steps:
- Step One: Sale of the Relinquished Property. Before the sale of the first property the Exchanger must add certain facilitating language into the Exchanger’s Contract for Sale and complete the additional documentation prepared by the Qualified Intermediary. On closing, the closing proceeds are delivered directly to the Qualified Intermediary.
- Step Two: Identification of the Replacement Property. The Exchanger must identify the property to be purchased (generally called the “Replacement Property”) within 45 days following the sale of the Relinquished Property. The taxpayer may generally identify up to three properties as a potential Replacement Property, or more subject to certain restrictions.
- Step Three: Purchase of the Replacement Property. The Exchanger must obtain the Replacement Property within 180 days following the sale of the Relinquished Property, which must be identified property, subject to the rules listed above. On closing, the closing proceeds are paid directly by the Qualified Intermediary, and the Exchanger receives the Deed to the Replacement Property.
There are other types of exchanges, such as reverse exchanges, improvement exchanges, and personal property exchanges.
The information contained herein is for informational purposes only and does not constitute tax, legal or accounting advice. You are advised to seek appropriate professional advice regarding your facts and circumstances.
GLOSSARY
Here, you will find definitions of terms and phrases frequently used in the
world of 1031 Exchanges.
1031 Exchange
A 1031 Tax Deferral permits taxpayers to reinvest the proceeds from the sale
of property held for investment or business purposes into another investment
or business property, and defer capital gains tax that would otherwise be due
on the initial sale.
Adjusted Basis
The original basis plus improvement costs minus the depreciation of the property.
Agreement for Transfer
Purchase agreement, sale agreement, earnest money agreement, offer & acceptance,
real estate contract or other contract contemplating the purchase or sale of
real property.
Boot
Property the taxpayer receives in the exchange which does not qualify as “like-kind
property”. Cash proceeds are the most common form of boot. Boot is subject
to taxation.
Capital Gain
Capital gain is calculated as follows: total selling price of the relinquished
property, less exchange expenses, less the relinquished property’s adjusted
basis. The adjusted basis is the original cost, plus the cost of capital improvements,
less depreciation or cost recovery deductions. Capital gains may be subject
to depreciation recapture and other rules of the internal revenue service.
Constructive Receipt
A term that refers to the exchanger having unrestricted control of the equity
from the property sold. Constructive receipt will invalidate a tax deferred
exchange
Cooperation Clause
Clause added to the purchase on sales agreement requiring the person who is
not the exchanger to use their best efforts to assist the exchanger in consummating
a 1031 tax deferred exchange.
Exchanger
The owner of the investment property looking to make a tax deferred exchange.
Unfortunately an exchanger cannot be an owner that wishes to defer capital gains
tax on a “second home”. See like-kind property definition.
Exchange Funds Account
The account established by the qualified intermediary to hold the exchange funds.
Exchange Period
The 180-day window in which the exchanger has to complete a tax deferred exchange.
During the exchange period there is a 45-day identification period in which
the exchanger must identify which property or properties will be purchased.
Fair Market Value
The likely selling price as defined by the market at a specific point in time.
Identification Period
The time period that begins upon the close-of-escrow of the relinquished property.
During this 45-day period, the exchanger must identify the replacement property
in order to continue with the section 1031 exchange transaction.
IRS §1031
Internal revenue code section 1031.
Like-Kind Property
The properties involved in a tax deferred exchange must be similar in nature
or characteristics. Like-kind real estate property is basically any real estate
that isn’t your personal residence or a second home.
Original Basis
The purchase price of a property. It is used to calculate capital gains or losses
for tax purposes.
Personal Property
Any property belonging to the exchanger that is non-real estate related.
Phase 1
The process in which the relinquished property is sold and all respective paper
work for that process is completed. This process is also known as the “down-leg”
of the tax deferred exchange process.
Phase 2
The process in which the replacement property is bought and all the respective
paperwork for that process is completed. This process is also known as the “up-leg”
of the tax deferred exchange process.
Qualified Intermediary
Intermediary, QI, accommodator, facilitator, qualified escrow holder. A third
party that helps to facilitate the exchange.
Real Estate Exchange
Exchange of real property for real property. All types of real property are
like-kind for other real property, including vacant land, residential, commercial,
and even long term leases.
Relinquished Property
The original property being sold by the taxpayer when making an exchange.
Replacement Property
The new property being acquired by the taxpayer when making an exchange.
Settlement Agent
Title agent, closing officer, escrow officer, settlement officer, closing agent,
closing attorney, settlement attorney.
Tax Advisor
Accountant, CPA, financial advisor, tax attorney.
Taxpayer
Client, investor, exchanger.
Tax Deferred Exchange
The procedure outlined under Internal Revenue Code Section 1031 involving a
series of rules and regulations that must be met in order to take full advantage
of deferring capital gains tax on the sale of investment real estate. §1031
tax-deferred exchanges are also commonly known as: Starker exchanges, delayed
exchanges, like-kind exchanges, 1031 exchanges, section 1031 exchanges, tax-free
exchanges, nontaxable exchanges, real estate exchanges, real property exchanges.
Though all of these terms refer to the same thing, the most typical term used
today is tax deferred exchange.
Tenancy In Common (TIC)
A fractional ownership interest in a piece of property, rather than owning the
entire piece of property. (more)
