A BRIEF OVERVIEW:
Since 1921, the tax strategy created IRC Section 1031. The tax deferred exchange
has been taken advantage of by investors and real estate professionals. You can
accumulate and preserve real estate assets by learning how to defer capital gain
taxes when disposing of any property “held for investment.” A properly structured
exchange can allow an investor to sell a property, reinvest the proceeds in a new
property and defer all capital gain taxes. As IRC Section 1031 (a) (1) states:
“No gain or loss shall be recognized on the exchange of property held for productive
use in a trade or business or for investment, if such property is exchanged solely for
property of like- kind which is to be held for productive use in a trade or business
or for investment.”
Both the “relinquished” and “replacement” properties must be held for investment or used in a business. The IRS term LIKE-KIND is described for the type of properties that would qualify. Any property held for investment can be exchanged for any other LIKE-KIND property held for investment. This would cover a variety of developed and undeveloped real estate.
The IRS does require an investor to identify the replacement property(s) within 45 days from closing on the sale of a relinquished property. The 45 day identification period will begin on the closing date and the replacement property(s) must be properly identified in a letter signed by the Exchanger and received by the Qualified Intermediary or the exchange company.
Closing on the replacement property should be on or before 180 calendar days after the closing of the sale of the relinquished property or the due date for filing the tax return for the year in which the relinquished property was sold, whichever is earlier (unless an extension has been filed).
To defer all capital gain taxes, an Exchanger must buy a property or properties of equal or greater value and reinvest all the net proceeds from the sale of the relinquished property. Any funds not reinvested, or any reduction in debt liabilities not made up for with additional cash from the Exchanger, is considered “boot” and this is taxable.
NOTE: You will need to provide the exchange company with a Real Property Sales Contract to start this procedure.
SOME QUESTION YOU MIGHT HAVE
- Can I take some cash at the time I close my relinquished (sale) property?
You may take cash at closing. The cash you receive may be taxable.
- Can I exchange a house used only as a primary residence?
No. Section 1031 applies to property held for business, trade or investment.
This would exclude the seller's residence or property held for resale.
- What if the Exchanger is taking title to the replacement property in a name that is different than your exchange documents?
The tax entity that sold the relinquished property is the tax entity that must acquire the replacement property.