Specialists in 1031 Tax-Deferred Exchanges for Real Estate
and Other Investment Property
You can exchange one property for another and defer paying any federal income taxes on the transaction.
Section 1031 of the Internal Revenue Code provides an extraordinary 100% deferral of taxes on realized gain and accumulated depreciation recapture if you sell a qualified investment property or business related real estate and replace it with another within a specified time and meet other provisions of the law.
These tax-deferred exchanges can play a variety of value-enhancement roles in portfolio management, including consolidating, diversifying or reallocating your investments, as well as increasing cash flow and dealing with issues of management and geography. They can also provide significant retirement and estate planning benefits. And they can be used for a variety of investment property, not just real estate, as long as the properties are of “like kind.”
The tax deferral gives the taxpayer the benefit of continuing use of the funds that would otherwise have been paid in taxes. In addition, if the property is held until the taxpayer dies, the gains tax liability is forgiven and the estate’s new basis becomes the stepped up value of the property at the time of the taxpayer’s death.
A 1031 exchange is not limited to an exchange between two parties (although this is one possibility). It is comprised of the sale by you of one property or a group of properties (known as the “relinquished property”) to a buyer and the purchase by you of another (known as the “replacement property”) from a seller.
In a typical tax-deferred exchange, four parties are involved: you, the Taxpayer; the Seller; the Buyer and the Intermediary -- usually called the QI, for “qualified intermediary.” The role of the QI is to sell your property on your behalf and buy the replacement, while ensuring that the transaction is properly structured. You pay a fee for these services.
Although tax-deferred exchanges take a variety of forms to meet different circumstances and objectives, to qualify they all must meet certain requirements.
These requirements, which are not difficult to accommodate with the assistance of the independent, professional Qualified Intermediary, include, but are not limited to:
• Real property must be exchanged for real property. Both must be held for investment or for productive use in a business.
• The replacement property must have a greater market value than the relinquished property. The transaction must be a trade up both in value and in equity and all of the proceeds of the sale – or more – must be used in acquiring the replacement property. You can take cash out, but it will be subject to tax.
• Ownership of the replacement property must be in the same name as ownership of the relinquished property.
• The replacement property must be identified within 45 days of the sale of the relinquished property and the second closing must take place on or before the earlier of 180 days after the first closing or the
Taxpayer’s income tax due date for that year. In a reverse exchange, where the replacement property
is acquired first, the sale of the relinquished property must close within 180 days.
• Except in a simple two-party swap, a QI must participate.
1031 tax-deferred exchanges are not limited to real property.
As long as the properties exchanged are “like kind,” a wide variety of investment vehicles are eligible for 1031 exchanges. All real property is considered like kind, from vacant land to skyscrapers, but real property cannot be exchanged for personal property. Other property that is eligible includes artwork, boats, aircraft, equipment, racehorses, livestock, and natural resources such as oil, gas, minerals and water rights. As long as the properties exchanged are “like kind,” a wide variety of investment vehicles are eligible for 1031 exchanges.
Different types of exchanges can be structured to deal with various situations. Here are the most common:
The simultaneous transaction with an intermediary –
The buyer pays cash to the intermediary for the relinquished property and takes title. The intermediary
pays cash to the seller for the replacement property and transfers title to the taxpayer. For the transaction to be tax-deferred, the taxpayer may not receive cash.
The deferred exchange with intermediary –
This occurs when the taxpayer sells the relinquished property before the replacement property has been identified. Here, the taxpayer conveys title to the buyer who pays cash to the intermediary. The taxpayer must find the replacement property within 45 days. The intermediary pays cash to the seller and must close the acquisition within 180 days of the first closing or the taxpayer’s income tax due date, whichever is earlier.
The reverse exchange –
When the taxpayer, for whatever reason, needs to close on the replacement property before he has a buyer for the relinquished property, he must resort to the reverse exchange, which is more complex and requires the participation of a fifth party, the Exchange Accommodation Titleholder, with whom the replacement property is “parked.” The reverse exchange can take a variety of forms, to accommodate the individual circumstances, but in any case, the taxpayer must provide the resources for the acquisition of the replacement property, title must be held by the EAT and a QI has a role in the process.
Other possibilities
More sophisticated tax-free exchanges are possible to meet specific situations, such as the need for construction or improvements involving one or both of the properties, the inclusion of more than one property on either or both of the relinquished and replacement sides and the need to defer a portion of a reverse exchange in order to meet the time constraints.
The involvement of a Qualified Intermediary throughout the process is required
and your choice of an experienced expert to act as your advisor and to provide the needed services in this capacity is crucial to your success.
The participation of a QI in your 1031 tax-deferrals is not a substitute for the advice of your own legal and accounting professionals, whose guidance is critically important, particularly in the more complex exchange structures and where there are special ownership, debt, tax and other issues. Your QI must be an independent who has no other contact with you and cannot have any business or family relationship with you.
The QI’s functions include:
• Timely, thorough and accurate preparation of documents;
• Assignment of sales contract, receiving proceeds and holding them for transfer to the seller;
• Advice on the variety of qualified arrangements that can meet your needs;
