Tax deferred 1031 exchange tips

Feb 6, 2007 | No Responses

This information was provided by Ten Mile Exchange Services in Breckenridge.  http://1031xchanges.com

IRC Section 1031 Exchange

Section 1031 is a provision of the Internal Revenue Code which governs tax-deferred or “Starker” exchanges.  The Tax Reform Act of 1984 simplified the rules and regulations governing tax-deferred exchanges.  With proper structuring, Section 1031 allows a taxpayer to dispose of a property (called the “Relinquished Property”) and acquire another property (called the “Replacement Property”) without incurring a current federal income tax liability.  Several conditions must be satisfied to qualify under Section 1031.  First, the proceeds from the disposition of the Relinquished Property must be held by a “Qualified Intermediary”.  In addition, the properties involved in the exchange must be of “like-kind”, and two critical time requirements must be satisfied.

Time Requirements

Section 1031 requires an Exchangor to identify its potential Replacement Property(ies) within 45 days after the closing of its Relinquished Property.  Generally, an Exchangor is limited to identifying three potential Replacement Properties.  In addition, an Exchangor must acquire its Replacement Property(ies) within 180 days from the closing of its Relinquished Property.  The failure to meet either of these time requirements will prohibit the Exchangor’s ability to defer tax using a Section 1031 exchange.

Like Kind Requirement

To qualify as a tax-deferred exchange, the Relinquished Property and the Replacement Property must be of “like-kind” and the exchanged properties must be held either for investment or for use in the taxpayer’s trade or business.  Land is an example of investment property.  A rental property is an example of property used in a trade or business.  Generally, investment property may be exchanged for trade or business property.  However, real estate must be exchanged for other real estate and personal property must be exchanged for other personal property.  In the case of real estate, the type of property is not important.  Accordingly, land, office buildings, apartments, rental homes and condominiums are all real estate and qualify as “like-kind” property.

Replacement Property Identification

Section 1031 requires an Exchangor to identify its potential Replacement Properties within 45 days of the closing of its Relinquished Property.  Section 1031 allows an Exchangor to identify up to three properties.  An Exchangor may identify more than three properties if the value of the identified properties does not exceed two times the value of the Relinquished Property, or if the Exchangor acquires 95% of the properties identified.  Under this latter exception, the 95% test is based on the fair market value of the properties.

Commom Misconceptions Regarding Exchanges

Section 1031 may cause an exchange to be partially or fully taxable if the Exchangor receives any cash from the exchange; if the Exchangor provides the buyer with financing; or if the purchase price of the Replacement Property is less than the sales price of the Relinquished Property.  In addition, Section 1031 prohibits a taxpayer from selling its property and acquiring another property without engaging the services of a “Qualified Intermediary”.