1031 TAX EXCHANGES

A Tax haven for promoting wealth
The 1031 tax deferred treatment of capital gains is one of the best real estate investor vehicles for preserving and building real estate wealth. This provision of the Internal Revenue Code allows property owners to exchange their property for other like-kind property without recognition or payment of capital gains at the time of exchange. In some instances it is possible to defer the payment of capital gains tax indefinitely.

The deferred exchange is different than a swap
Exchanging properties is not new. The "your property" for "my property" type of direct exchange (i.e., a swap) has been in practice for a long time - it's called a two-party exchange. The difficulty lies in finding two owners who each want the other's property. Normally, one owner wants to sell. This presents a problem if you want to dispose of property to finance the acquisition of new property and avoid taxable gains that would substantially reduce your equity.

To solve the dilemma the IRS issued the deferred exchange regulation-Reg 1.1031(k)-1. It permits you to "sell" your Relinquished Property now and use the proceeds to buy a Replacement Property later. As long as it's done following the rules and using the services of a Qualified Intermediary, you get tax deferred 1031 treatment.

Qualified Intermediary
The Deferred Exchange Regulation is a taxpayer's dream come true. The Regulation's secret weapon is the creation of a legal entity called the Qualified Intermediary or QI. This new entity is permitted to serve as your agent and facilitate the exchange for you without getting you involved in a taxable sale of your old property. By using a Qualified Intermediary to handle your exchange transaction, you can now turn the sale of your property, and subsequent purchase of another "like-kind" property, into a §1031 exchange.

The selection of a QI is one of the most important decisions you will make in a §1031 Exchange since the QI will, at some point in the transaction, be holding your money in their account. The industry is largely un-regulated so the burden falls on you, the consumer, to be diligent in your search for a reputable QI. A real estate agent with experience in §1031 Exchanges will be able to point you in the direction of a good QI.

How It Works
There are some basic rules you must follow in any §1031 Exchange: Both old and new properties must qualify as investment or business use. Once you close on the property you are selling, you have 45 days to list any properties you may want to buy. You then have 180 days from the close of your old property to close on the new property or properties from the list. The proceeds from the initial sale must be held by the QI so that you do not have access to the money.

This is only a brief explanation of a §1031 Exchange. The actual mechanics of the exchange, while simple, require strict adherence to the regulations at every stage or the tax deferral could be disallowed. It is imperative that you consult with an experienced Qualified Intermediary prior closing any sale that you may wish to qualify for §1031 treatment.

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1031 TAX EXCHANGES