What is
a Deferred
1031Exchange?
A tax
deferred 1031 exchange
represents a simple,
strategic method for selling one qualifying property and the subsequent
acquisition of another qualifying property within a specific time frame.
Although the logistics of selling one property and buying another are
virtually identical to any standard sale and purchase scenario, an
exchange is different because the entire transaction is memorialized as
an exchange and not a sale.
And it is this distinction
between exchanging and not simply selling and buying which ultimately
allows the taxpayer to qualify for deferred gain treatment. So
essentially, sales are taxable and exchanges are not.
Real Estate Brokers
Internal
Revenue Code, Section 1031
Because exchanging
represents an IRS-recognized approach to the deferral of capital gain
taxes, it is important for us to appreciate the components and intent
underlying such a tax deferred or tax free transaction. |
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Why 1031?
Any property owner or investor who
expects to acquire replacement property subsequent to the sale of his
existing property should consider an exchange. To do otherwise would
necessitate the payment of capital gain taxes in amounts which can
exceed 20-30%, depending on the appropriate combined federal and state
tax rates. In other words, when purchasing replacement property without
the benefit of an exchange, your buying power is dramatically reduced
and represents only 70-80% of what it did previously.
Basic 1031 exchange rules
Let us look at a basic concept, which
applies to all exchanges. Utilize this concept to fully defer the
capital gain taxes realized from the sale of a relinquished property:
1. The purchase price of the replacement property must be equal to or
greater than the net sales price of the relinquished property, and
2. All equity received from the sale of the relinquished property must
be used to acquire the replacement property.
To the extent that either of these rules is abridged, a tax liability
will accrue to the Exchangor. If the replacement property purchase price
is less, there will be tax. To the extent that not all equity is moved
from the relinquished to the replacement property, there will be tax.
This is not to say that the exchange will not qualify for these reasons;
partial exchanges do in fact qualify for partial tax deferral. It simply
means that the amount of any discrepancy will be taxed as boot, or
non-like-kind, property.
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Four common 1031exchange
misconceptions:
1. All 1031 exchanges must
involve swapping or trading with other property owners. (NO)
Before delayed exchanges were codified in 1984, all simultaneous
exchange transactions required the actual swapping of deeds and
simultaneous closing among all parties to an exchange. Often times these
exchanges were comprised of dozens of exchanging parties as well as
numerous exchange properties. But today, there is no such requirement to
swap your property with someone else in order to complete an exchange.
The rules have been streamlined to the extent that the current process
is reflective more of your qualifying intent rather than the logistics
of the property closings.
2. All 1031 must close simultaneously. (NO)
Although there was a time when all exchanges had to be closed on a
simultaneous basis, they are rarely completed in this format any longer.
In fact, a significant majority of exchanges are now closed as delayed
exchanges.
3. Like-kind means purchasing the same type of property which was sold.
(NO)
The definition of like-kind has often been misinterpreted to mean the
requirement of the acquisition of property to be utilized in the same
form as the exchange property. In other words, apartments for
apartments, hotels for hotels, farms for farms, etc. However, the true
definition is again reflective more of intent than use. Accordingly,
there are currently two types of property that qualify as like-kind:
- Property held for investment, and/or
- Property held for a productive use in a trade or business.
4. 1031 must be limited to one exchange and one replacement
property. (NO)
This is another exchanging myth. There are no provisions within either
the Internal Revenue Code or the Treasury Regulations that restrict the
amount of properties that can be involved in an exchange. Therefore,
exchanging out of several properties into one replacement property or
vice versa, relinquishing (selling) one property and acquiring several,
are perfectly acceptable strategies.
Tenant in Common | 1031 Exchange Tax | Reverse 1031 | TIC | 1031
Accommodator. |
