The last remaining tax shelter for the disposition of real property!
A tax deferred exchange, as defined in Section 1031 of the Internal Revenue Code of 1986, as amended, offers real estate investors one of the last great investment opportunities to build wealth and save taxes. By completing an exchange, the investor (Exchanger) can move from their existing investment property to another investment property and defer the capital gain tax that would ordinarily be paid.
There are several requirements that must be met to defer the capital gain tax: (a) the Exchanger must acquire "like kind" replacement property and (b) the Exchanger cannot receive cash or boot (unless the Exchanger pays capital gain taxes on this boot). In any exchange the Exchanger must enter into the exchange transaction prior to the close of the relinquished property. The exchange can take place direct between two parties. Party A transfers their property to Party B and Party B transfers their property to Party A. This type of exchange is uncommon. In most cases Party A wants Party Bs property but Party B wants Party Cs property. When there are multiple parties it is necessary to use an intermediary. The Exchanger and the intermediary enter into an Exchange Agreement, which essentially requires that (a) the intermediary acquires the relinquished property from the Exchanger and transfers it to the buyer by a direct deed from the Exchanger and (b) the intermediary acquires the replacement property from the seller and transfers it to the Exchanger by a direct deed from the seller.
The cash or other proceeds from the relinquished property are assigned to the intermediary and are held by the intermediary in a separate, secure account. The exchange funds are used by the intermediary to purchase the replacement property for the Exchanger.
IMPORTANT CONSIDERATIONS FOR AN EXCHANGE
Exchanges must be completed within strict time limits with absolutely no extensions. The Exchanger has 45 days from the date the relinquished property closes to "Identify" potential replacement properties. This involves a written notification to the intermediary listing the addresses or legal descriptions of the potential replacement properties. The purchase of the replacement property must be completed within 180 days after of the close of the relinquished property. After the 45 days has passed, the Exchanger may not change their Property Identification list and must purchase one of the listed replacement properties or the tax deferred exchange fails
To avoid the payment of capital gain taxes the Exchanger should follow three general rules: (a) purchase a replacement property that is the same or greater value as the relinquished property, (b) do not receive (unlike property such as cash, debt relief, personal property, non-like property)
In the case of real property exchanges, the Exchanger must sell property that is held for productive use in a trade or business or for investment and acquire replacement property that will be held for productive use in a trade or business or for investment This is the "like kind" property test.
I.R.C Section 1031 does not apply to exchanges of stock in trade, inventory, property held for sale, personal residence, stocks, bonds, notes, securities, evidences of indebtedness, certificates of trust, or beneficial interests or interests in a partnership.
1031 exchange Benefits
- Deferred tax payment
- Use of tax dollars to reinvest
- Possible reduced tax
A convenience exchange is a exchange that in not tax deferred but were the exchangers wish to divest themselves of their property and rather than sell the property and using the proceeds to purchase another property they directly exchange. This oftentimes produces a higher value for their property and a expedited transaction.
The Exchanger is always advised to discuss the intended exchange with their legal or tax advisor
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