1031 Exchange

  • COMMONLY REFERRED TO AS A "1031 EXCHANGE", A TAX-DEFERRED EXCHANGE ALLOWS YOU TO PRESERVE YOUR WEALTH THROUGH REINVESTMENT IN "LIKE-KIND" ASSETS. AS YOUR REAL ESTATE PROFESSIONAL, THE CAPITAL CORPORATION STANDS READY TO ASSIST YOU WITH YOUR DISPOSITION OF EXISTING PROPERTY AND THE IDENTIFICATION AND ACQUISITION OF A REPLACEMENT PROPERTY.

    Overview of a tax-deferred exchange:

    When you sell your interest in investment property, you may incur federal capital gains taxes and, in some states, state taxes as well. Your attorney, tax advisor, and/or real estate professional may suggest a tax-deferred exchange under Section 1031 of the Internal Revenue Code. A tax-deferred exchange allows you to dispose of investment properties and acquire "like-kind" properties while deferring federal capital gains taxes and depreciation recapture. Most states with a capital gain tax offer a similar tax advantage, too. Bottom line: a tax-deferred exchange allows you to reinvest sales proceeds that would otherwise be paid to the government in the form of taxes.

    Section 1031 of the Internal Revenue Code provides a remarkable opportunity to build wealth by deferring taxes. Within carefully defined limits, this section of the Code permits you to carry forward the gains you have made on one property into another one, deferring capital gains taxes and, thus, allowing the full use of your equity in the acquisition. An exchange can be much more advantageous than the sale of one property and the purchase of another.

    Any real or personal property can be exchanged, provided it is held "for productive use in a trade or business" or "for investment" and is exchanged for property of "like-kind" that will also be held for one of these same purposes. "Like-kind" does not mean "exactly the same," particularly with the exchange of real property. A single-family rental unit, for example, may be exchanged for other real property like a warehouse, retail center, office building, farm property, or even a leasehold interest in real estate of 30 years or more. Most real property is considered "like-kind" to other real property. "Like-kind" limitations on personal property are more restrictive.

    The General Requirements for a Tax-Deferred Exchanges are:

     

    IDENTIFICATION PERIOD

    The replacement property must be identified within 45 days of the transfer of the first relinquished property. This 45-day rule may not be extended even if the 45th day should happen to fall on a Saturday, Sunday or legal holiday.

    EXCHANGE PERIOD

    The acquisition of your replacement property must be completed by the earlier of:

    1. 180 days of the transfer of your first relinquished property; or

    2. The due date of filing your federal income tax return for the year in which you transferred the first relinquished property, including extensions. This 180-day rule may not be extended even if the 180th day should happen to fall on a Saturday, Sunday or legal holiday.

    Closing of Relinquished Property image

    FULLY DEFERRED EXCHANGES

    For your exchange to be fully tax-deferred, your replacement property(ies) must be equal to or greater in value and equity than your relinquished property. The debt on your replacement property(ies) must also be equal to or greater than the debt on your relinquished property, unless cash is added to offset debt.

    IDENTIFICATION RULES

    You may identify replacement property according to the following rules:

    •    3-property rule - Three properties, regardless of value; or
    •    200 percent rule - Any number of properties, as long as their combined fair market value does not exceed twice the value of the relinquished property; or
    •    95 percent rule - Any number of properties, regardless of their combined fair market value, as long as you acquire 95 percent or more of the total value of such properties.

    TAKING THE PROPER STEPS

    [step 1] Purchase Contract-relinquished property

    You and your buyer enter into a purchase contract with respect to the sale of your property (known as the "relinquished property"). This relinquished property purchase contract should contain a "cooperation clause" obligating the buyer to cooperate in structuring the transaction as a tax-deferred exchange.

    [step 2] Relinquished property exchange documents

    Next, select an Intermediary to start the tax-deferred exchange process. He will prepare an 'Exchange Agreement', an 'Assignment of the Relinquished Property Purchase Contract' (assigning your rights as seller to Intermediary), a 'Notice of the Assignment' (for delivery to the buyer), and instructions to the settlement agent necessary to complete the transaction. All of these documents must be signed and dated before or as of the date of closing.

    [step 3] Closing the relinquished property

    When the conditions of closing have been met, your relinquished property will be conveyed to the buyer. While the conveyance will be directly from you to the buyer, it will represent a transfer from you to the Intermediary in exchange for other property that you will receive at a later date. It also represents the sale from the Intermediary to be buyer for cash. The cash proceeds from the sale of the relinquished property must be delivered directly to the Intermediary. At no time can you be in either actual or constructive receipt of the cash proceeds.

    [step 4] Relinquished property proceeds and forms

    Following the relinquished property closing, First American Exchange will hold the exchange proceeds and provide you with forms to identify potential replacement properties within the 45-day identification period.

    [step 5] Purchase Contract - replacement property

    After you have identified suitable "like-kind" replacement properties and made a decision as to which identified properties you intend to acquire, you will enter into a 'Purchase Contract' with the seller. This 'Replacement Property Purchase Contract' should also contain a "cooperation clause" obligating the seller to cooperate with you in completing your tax-deferred exchange.

    [step 6] Replacement property exchange documents

    The Intermediary will then prepare an 'Assignment of the Replacement Property Purchase Contract' (assigning your rights as buyer to Intermediary), 'Notice of the Assignment' (for delivery to the seller), and instructions to the settlement agent necessary to complete the transaction. All of these documents must be signed before or as of the date of closing.

    [step 7] Closing the replacement property

    When the conditions of closing have been met, the Intermediary will deliver the exchange proceeds to the settlement agent to acquire the replacement property. The seller will convey the replacement property directly to you. This conveyance will represent a purchase from the seller by the Intermediary and a transfer to you in completion of the exchange. Remember that, to qualify for tax-deferred treatment, this closing must occur by the earlier of 180 days from the date of closing on your first relinquished property or the due date of filing your federal income tax return for the year in which your first relinquished property was sold, including extensions.

    [step 8] Keeping you informed and final reconciliation

    Prior to or at the conclusion of your exchange, the Intermediary and The Capital Corporation will provide you with a copy of your exchange documents, including a statement reflecting the receipt and disbursement of all exchange funds. With this information, you and your tax advisor will complete Form 8824 to be filed with your federal income tax return, as well as any state forms required to report the transaction as an exchange.

    SPECIAL CIRCUMSTANCES TO BE CONSIDERED

    Certain provisions of the regulations must be taken into account for the qualifications, structure, and documentation of your exchange. If any of the following circumstances apply to your transaction, additional information will need to be considered:

    •    Disposition of a property held by a partnership, corporation, or limited liability company
    •    Exchanging property with a related party
    •    Disposition of property held in a living trust
    •    Receiving cash from the exchange
    •    Acquiring property of a lesser value than the relinquished property
    •    Carrying financing on the relinquished property (seller carry back note) Acquiring replacement property in the following tax year
    •    A reverse exchange transaction
    •    Improvements that will be made to the replacement property (construction/improvement exchanges)
    •    Acquiring replacement property with spouse or others who were not a party to the exchange
    •    Combination exchange, part investment property (IRC Section 1031) and part owner occupied (IRC Section 121)
    •    Residing in a state other than the relinquished property
    THE CAPITAL CORPORATION LOOKS FORWARD TO THE OPPORTUNITY OF WORKING WITH YOU ON ANY DEFERRED EXCHANGE YOU MAY HAVE ASSOCIATED WITH REAL ESTATE.