Considering a Tax-Deferred 1031 Exchange?
In a typical sale of investment or commercial property, the owner can be taxed on any capital gains realized by the sale. However, the 1031 exchange rule allows an investor to defer payment of capital gains tax by disposing of one investment property and exchanging into another without incurring immediate tax liability. Thus, the earning power of the tax deferred dollars continues to work for the investor through the new investment property.
Keystone Realty 1031 exchange real estate services specialists help investors locate 1031 exchange properties and prime investment property in California. We understand the time constraints associated with identifying 1031 exchange real estate and we are pleased to help our buyers find replacement investment properties quickly.
How do we help?
- Connect you with our reputable Qualified Intermediaries
- Assist you in finding replacement properties
- Serve as your 1031 Exchange RE Agent/Broker
- Help you locate a professional 1031 Attorney or Accountant
- Most importantly, we answer any 1031 related questions
Why 1031 Exchange?
Any Real Estate property owner or investor of Real Estate, should consider an exchange when he/she expects to acquire a replacement “like kind” property subsequent to the sale of his existing investment property. Anything otherwise would necessitate the payment of a capital gain tax, which can exceed 20-30 percent, depending on the federal and state tax rates of your given state.
To make it easy to understand, when purchasing a replacement property (without the benefit of a 1031 exchange) your buying power is reduced to the point, that it only represents 70-80 percent of what it did previously (before the exchange and payment of taxes).
Below is a look at the basic concept, which can apply to all 1031 exchanges. From the sale of a relinquished real estate property, we should understand this concept so that we can completely defer the realized capital gain taxes. The two major rules to follow are:
- The total purchase price of the replacement “like kind” property must be equal to, or greater than the total net sales price of the relinquished, real estate, property.
- All the equity received from the sale, of the relinquished real estate property, must be used to acquire the replacement, “like kind” property.
The extent that either of these rules are violated will determine the tax liability accrued to the person executing the Exchange. In any case which the replacement property purchase price is less, there will be a tax responsibility incurred. To the extent that not all equity is moved from the relinquished to the replacement property, there will be tax. This is not to say that the (1031) exchange will not qualify for these reasons. Keep in mind, partial exchanges do in fact, qualify for a partial tax-deferral treatment. This simply means that the amount, of the difference (if any), will be taxed as a boot or “non-like-kind” real estate property.
THE 1031 Exchange Rule
A property transaction can only qualify for a deferred tax exchange if it follows the 1031 exchange rule laid down in the US tax code and the treasury regulations.
The foundation of 1031 exchange rule by the IRS is that the properties involved in the transaction must be “Like Kind” and both properties must be held for a productive purpose in business or trade, as an investment.
The 1031 exchange rule also lays down a guideline for the proceeds of the sale. The proceeds from the sale must go through the hands of a “qualified intermediary” (QI) and not through your hands or the hands of one of your agents or else all the proceeds will become taxable. The entire cash or monetary proceeds from the original sale has to be reinvested towards acquiring the new real estate property. Any cash proceeds retained from the sale are taxable.
The second fundamental rule is that the 1031 exchange requires that the replacement property must be subject to an equal or greater level of debt than the property sold or as a result the buyer will be forced to pay the tax on the amount of decrease. If not he/she will have to put in additional cash to offset the low debt amount on the newly acquired property
1031 Exchange Rules and Timelines
There are two timelines that anybody going for a 1031 property exchange should abide by and know.
The Identification Period: This is the crucial period during which the party selling a property must identify other replacement properties that he proposes or wishes to buy. It is not uncommon to select more than one property. This period is scheduled as exactly 45 days from the day of selling the relinquished property. This 45 days timeline must be followed under any and all circumstances and is not extendable in any way, even if the 45th day falls on a Saturday, Sunday or legal US holiday.
The Exchange Period: This is the period within which a person who has sold the relinquished property must receive the replacement property. It is referred to as the Exchange Period under 1031 exchange (IRS) rule. This period ends at exactly 180 days after the date on which the person transfers the property relinquished or the due date for the person’s tax return for that taxable year in which the transfer of the relinquished property has occurred, whichever situation is earlier. Now according to the 1031 exchange (IRS) rule, the 180 day timeline has to be adhered to under all circumstances and is not extendable in any situation, even if the 180th day falls on a Saturday, Sunday or legal (US) holiday.
1031 Exchange Accommodators & Qualified Intermediaries
A Qualified Intermediary (QI) is responsible for performing the following activities in a 1031 Exchange:
- Acquiring the Relinquished Real Estate Property from the taxpayer himself
- Transferring the Relinquished Real Estate Property to the buyer himself
- Acquiring the Replacement Real Estate Property from the seller himself
- Transferring the Replacement Real Estate Property to the taxpayer himself
The Qualified Intermediary can actually perform all these without ever taking title to either of the properties. The Qualified Intermediary is responsible for properly filling out the appropriate tax forms for the client.
In a typical exchange the Qualified Intermediary (QI) typically provides three different documents:
- The exchange agreement
- An assignment
- A notice
The 1031 exchange agreement is a contract between the client and the Qualified Intermediary that sets out the rules and guidelines. This must be followed in order to complete the 1031 exchange. The assignment of the “sales contract” to the Qualified Intermediary must also be in place. This is in place because, in theory, the Qualified Intermediary steps into the client’s position and sells the property. The third document the Qualified Intermediary provides is a notice to the party on the other side of the transaction advising that the transaction is indeed a 1031 exchange. The purpose of notification to the other party is to prove, without doubt, that the 1031 exchange was in place at the closing.
An exchanger must be particularly aware of selecting a knowledgeable (QI) before going into the transaction. There are thousands of (QI) providing “like-kind” 1031 exchange services today. Most of the Qualified Intermediary don’t have the necessary insurance, financial backing, bonding, transactional structure, and internal safety controls that should be required of them. Even most exchange funds are often grossly under-insured, under-protected, and are at risk.
In today’s risky economic climate, choosing a financially secure, 1031 (QI) with the financial strength, resources, safeguards, and financial backing is critical for the safe completion of a 1031 “like-kind” exchange transaction with a Qualified Intermediary.
1031 Exchange Real Estate Investment Options
The types of real estate that qualify for a 1031 exchange under IRC Section 1031 include most real property held for investment. Some examples are:
- Raw land
- Motels and hospitality properties
- Office and retail buildings
- Apartments and multifamily properties
- Farms, horse farms, and agri-business property
- Warehousing and industrial real estate
- Single family rentals and vacation rentals
Sometimes called a like kind exchange, a 1031 involves the exchange of real property for real property. Thus, any combination of real property types can be exchanged. For example, a warehouse can be exchanged for an apartment building, a motel can be exchanged for raw land, or a bed and breakfast can be exchanged for a retail building. Also, an investor might opt to exchange one large investment property for several smaller investment properties.
To discuss replacement properties that are currently available, contact us with your 1031 exchange requirements. Also, we can provide details on listings found in the MLS.
What a real estate broker should do as part of a 1031 exchange
Samir Rai as a California licensed real estate broker working with a property investor conducting a 1031 exchange is able to perform the following duties:
Provide information that a 1031 Exchange is an option for any property sale pertaining to any business or investment property, or any owner occupied property sale that has an investment component. For example, a house with a farm that produces salable farm goods, a house with a unit in the back that is being rented, a building where someone is conducting their business, etc. It is recommended that the, for sale property owner talk to their tax and/or legal advisors about their specific situation. Any tax or legal information provided by a real estate agent should be secondary to the information provided by your accountant and legal advisor, especially as this pertains to the specific information pertaining to an actual 1031 exchange transaction that you are participating in. Your accountant should have specific financial information pertaining to your owned and for sale properties, while any information provided on this site is general information and not specific to your actual 1031 exchange needs.
Explain that the appropriate 1031 Exchange language needs to be added to the Purchase and Sale agreement, or as an attachment to the agreements as an addendum. real estate broker, Mark Sanguinetti can assist with this process in working with his clients chosen intermediary, financial lender, property inspector, tax accountant, title company, escrow company and/or legal advisor. A 1031 exchange account needs to be opened before the close of escrow for the sale of a property involved in a 1031 exchange. To open the account, you can work with real estate agent Samir Rai at 909.994.9090.
The replacement property or properties that need to be purchased under a 1031 exchange require a strict timeline. The first timeline is the identification and selection of the possible for purchase properties within 45 days of the close of escrow for the sale of your property for your 1031 exchange. This must be done in writing with the properties clearly stated. This identification needs to be sent to your Intermediary, for example Asset Exchange Company. For a real estate agent working with their 1031 exchange property owner client this 45 day period could require the most and quickest for sale property evaluation with the client in the property exchange making the final decision as to which properties to choose. Samir Rai can do a lot of property research for his client in helping him or her make their decision on possible for purchase properties.
The next timeline is the 180 day period, which also begins after the close of escrow for the sale of your property. This period extends beyond the first 45 day period by 135 additional days. A property can be purchased any time during this 180 day period including during the first 45 days of property evaluation, but the close of escrow for the newly purchased property or properties must be no later than this 180 day period. If, however, the due date of the exchanger’s tax return for the year during which the relinquished property was transferred is before the end of the 180 day period, the due date of the tax return is the end of the 1031 exchange period. Because the due date of the tax return includes extensions, the exchanger by filling out a tax return extension in a timely manner, which is form 4868, can then allow that the exchange period does not end prior to the end of the 180-day period. It is recommended that the exchanger work with his or her accountant for this form 4868 extension. This will extend the final due date for income tax filing from the middle of April to middle of October, for example depending on the exact year with calendar, April 15 to October 15. This will allow you extra days to finalize your purchase of property within your 180 day 1031 exchange period.
During this time period Samir Rai, as a licensed real estate broker can work with the escrow company and the Intermediary and whoever else the principal 1031 client wants me to work with. This can also involve, for example, a contractor used to evaluate the construction of the buildings and other property evaluation professionals.