The first step the taxpayer must do is to review their potential transaction. Was the property held for investment or in their trade or business? Was the property held long enough? The property must be held for one year, typically at the beginning. Following properties can be held for a shorter period of time.
Secondly, the taxpayer must select a well-qualified intermediary. The primary interest of the taxpayer is the safety of the funds. By far, the best and safest method is a dual signature account. Both the taxpayer and the intermediary must sign before any funds can be withdrawn from the account.
The next most important item is the experience of the intermediary. They should certainly be a Certified Exchange Specialist (CES). They must also be a member of the Federation of Exchange Accommodators, a national organization that keeps its members informed of the latest IRS rulings and tax law. The 1031 exchange business should be their full-time profession and not a sideline. They would also be extremely important if the intermediary was a real estate investor and exchanger for their own account. The taxpayer should have access to a certified exchange specialist on every phone call.
Real Estate owners who want to reinvest their proceeds tax-free have 180 days to close on a replacement property. These have to be identified within 45 days of the sale.Section 1031 of the Internal Revenue Code provides that the capital gains tax on the sale (15% tax) and any recapture of depreciation (25% tax) can be deferred by following the guidelines outlined in this section. This may be the best section in the code, since there is no limit on the amount of the deferral or how many times it may be used.
Currently at the death of the taxpayer, heirs receive the property at a stepped-up basis and no tax is due. The exchange must be set-up prior to or at the closing. Input forms are available on our web site and additional rules are there also. The site is 1031taxfreesale.com
This 1031 Exchange has been part of the Code since 1921. It provides that any estate in Real Estate (fee simple, air rights, 30 year leasehold, mineral rights, etc.) may be sold and any other type of investment property purchased, anywhere in the U.S., as long as the property is used in your trade or business or is held for investment purposes. Generally, this excludes your residence or any dealer property held for resale. There is no “exchange” of real estate, but a sale and a repurchase. The IRS view is that you have exchanged one investment position for another of equal or greater value and equal or greater debt. If so, no tax is due.
Personal property can also be exchanged such as aircraft, TV licenses, rental car fleets, livestock and many more types.
Example
After acquiring a small mobile home park a few years earlier, the owner managed it well, took a tax deduction for most of the fix-up costs, and moved in several homes that he sold on terms. With full occupancy and the needed fix-up work completed, the market value had increased substantially. The owner wanted to sell and use the money to acquire a larger rental property with even more profit potential.
After buying the park at a low price and taking depreciation for a few years, the owner's tax basis was only $100,000. With a market value of $300,000, a sale at that price would result in about $200,000 in capital gains. After finding a buyer for his park, the owner reinvested the sale proceeds in the larger park.
By deferring income taxes on the $200,000 gain, the owner was able to use his entire equity toward the purchase of a larger park that offered greater income and growth potential. Deferring income taxes could be compared to obtaining a loan that doesn't require any interest or payments. Money that otherwise would have gone to pay income taxes was used toward the purchase price of the larger property, thereby reducing the amount of financing that would be needed. With a smaller mortgage on the new property, both principal and interest payments were reduced.
The lower payments meant the owner would have more income left over. More importantly, the smaller mortgage and increased cash income resulted in less risk. The reasons for an exchange and the different ways it can take place are virtually unlimited. Even dealers are entitled to a tax-deferred exchange of property that was acquired for investment purposes and not as inventory.
The procedures to do a 1031 Exchange are simple and inexpensive. First, show intent by making the Sales Contract “assignable”. Second, contact a Qualified Intermediary to prepare the documents and escrow the funds. Third, start shopping for replacement properties. There have been many court cases and IRS rulings since 1921 on various aspects of exchanges.
“Tenant-in-Common Ownership”
This is the most recent improvement in 1031 Exchanges. The IRS issued guidelines for the purchase of replacement properties by a Tenant-In-Common deed to a large, professionally managed property, such as a Home Depot, Walgreen's, Office Building, Mall, and others. Since the Exchangor receives a deed, it is deemed to be real estate, even though it is net leased by the operator. Typically, these programs require a minimum investment of $50,000. They pay about 7% cash on cash. There is usually 1/3 cash to 2/3 non-recourse debt. Much of the cash flow is sheltered due to the debt. Hundreds of millions of exchanger's funds are flowing into these REIT type properties from investors looking for management free Real Estate Investments.
Oil and Gas royalties are also a popular choice for exchange investors. These are paying over 10% at this time. The properties are generally sold after about 5 years and investors can 1031 exchange into another Tenant-n-Common property.
Contact Keys Capital Inc. for currently available Tenant-in-Common projects.
Favorable guidelines also exist on:
PARTNERSHIPS — Procedures exist for partnership exchanges of property and distributions to the partners.
CONVERSION — Conversion of a property from an investment use to residential use and vice versa, have been allowed.
RELATED PARTIES — Exchange of properties with a related party have been defined.
LAND TRUSTS – Exchanges of Land Trust interests have been permitted.
TITLE HOLDER – Change of Title holding entity from personal to an LLC has been approved.
MULTIPLE PROPERTIES — Selling several properties and exchanging into one is permitted. Selling one property and buying any number is possible.
SELLER FINANCING — Seller held notes are permitted in an exchange to sell or keep the notes.
REFINANCING — Financing before or after the sale guidelines have been defined. CASH OUT – Cash Out (taxable) of an exchange is allowed with the remainder reinvested tax-free.
BUY/BUILD – Buying a lot and building a structure is Ok.
REVERSE EXCHANGES — Buying first and selling later, (a reverse exchange) Has recently been defined in detail by the IRS.
and more variations on all of the above have been granted tax-deferred states by the IRS.
