1031 Exchange:
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CITY 1031 EXCHANGE GUIDE |
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MESSAGE FROM BROKER/TOC
A. 1031 EXCHANGE BASICS
B. PASSING THE "PURPOSE"
TEST
C. LET'S TALK ABOUT BOOT
D. SOME ADVANCED 1031 TOPICS
A. 1031 EXCHANGE BASICS
1. What Is a “1031
Exchange”?
A 1031 exchange is simply the sale of one investment (commonly referred
to as the “relinquished” property) and the purchase
of another (commonly referred to as a “replacement”
property), with the sale and the purchase structured in a way that
meets IRS requirements published under Section 1031 of the Internal
Revenue Code. When properly structured, an investor is able to defer
the taxes that would otherwise be payable upon the sale of the relinquished
property.
2. Who Benefits
Most from Section 1031?
Section 1031 is most beneficial to investors that are in
the process of selling (or are contemplating selling) an existing
investment that has a low “tax basis”, resulting in
the likelihood of a significant “capital gains” or “recapture”
tax payments being due upon the sale. The phrase “basis”
generally refers to the investor’s initial investment, subject
to certain accounting adjustments over time. An investor is most
likely to have a relatively low tax basis (and potentially significant
tax liability) where either (or both) of these circumstances apply:
(a) the property has appreciated in value since the time of purchase;
or (b) the investment consisted of improved real estate and the
investor has been claiming annual “cost recovery” deductions
(also known as depreciation deductions) that will need to be “recaptured”
(or reconciled with reality) at the time of a taxable sale.
3. What Are the
“Safe Harbor” Regulations?
“Safe Harbor” is a phrase that refers to the 1031 exchange
guidelines published by the IRS. Prior to the publishing of those
guidelines, it was very difficult to know whether a 1031 exchange
was legitimate or not. Since the publishing of the guidelines, almost
all tax professionals have advised their clients to structure their
1031 exchange in a way that fully complies with the “safe
harbor” regulations established by the IRS.
4. What is
a Qualified Intermediary?
A “qualified intermediary” is an independent
third party that holds the cash proceeds from the sale of the relinquished
property pending the acquisition of the replacement property. The
“safe harbor” regulations regarding the role of the
qualified intermediary are quite dense. Thus, it is important to
select an intermediary that is experienced with Section 1031 and
its “safe harbor” regulations.
5. How Do the 45-Day
and 180-Day Rules Work?
Most taxpayers don’t acquire their replacement property on
the same day that they sell their relinquished property. Instead,
they follow the “safe harbor” rules published by the
IRS that permit the replacement property to be first identified,
and then acquired, on subsequent dates. Among the most critical
of the “safe harbor” rules are the 45 day identification
period and 180 closing period:
- 45 Day Identification Period.
The taxpayer must identify the intended replacement property or
properties within 45 days of the closing of the sale of the relinquished
property.
- 180 Day Closing Period.
The taxpayer must close the purchase of the replacement property
(or properties) within 180 days of the closing of the sale of
the relinquished property (or sooner in some cases if the taxpayer’s
deadline for filing a tax return occurs sooner). The 45 day period
and the 180 day period run concurrently and not
successively.
6. How Many
Properties Can I Identify as Potential Replacement Properties?
There is a limit on the number of properties that you can
identify. The IRS allows you to use one of two formulas:
- Three Property Rule.
You can identify up to 3 potential replacement properties, regardless
of their value. This is the method used by most taxpayers.
- 200% Rule.
Some taxpayers want to identify more than 3 potential replacement
properties. This is permissible so long as the total value of
the identified replacement properties does not exceed 200% of
the value of the relinquished property.
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