1031 Tax Deferred Exchanges are a great way to defer tax
payments that would normally be due on real estate transactions.
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Generally, when individuals sell real estate,
they have to pay tax on the gain from the sale of the property.
This gain is caused either by the property appreciating over
time or by the individuals taking depreciation deductions for
tax purposes.
A Section 1031 Exchange offers the
major exception of this capital gains tax. In a nutshell,
if the taxpayer sells business or investment real estate and
places it with business or investment real estate, he or she can
defer the payment of the tax that is normally due on the
transaction.
To qualify for the exchange, the taxpayer
must trade real estate for real estate used for business or
investment purposes. For example, raw land may be
exchanged for an apartment, a rental house, or a business
warehouse, and vice versa. It cannot, however, be traded
for a personal residence. A personal residence does not
qualify for a tax deferral under Section 1031.
Until 1970, it was assumed that all 1031 exchanges had to
be simultaneous. However, in the landmark T.J. Starker
case, the 9th Circuit Court of Appeals eliminated the
necessity for the disposal and acquisition to be at the same
time. Under the 1984 Tax Reform Act, the taxpayer has
45 days from the date of disposal to identify the property
to be acquired and a total of 180 days to complete the
acquisition.
One of the most important aspects of structuring
a tax-deferred exchange is to avoid the
constructive receipt of the proceeds of the
property being given up in the exchange.
This means that at no time can the proceeds
(cash or paper) come under the control of the
taxpayer. The taxpayer would be considered
to have control of the proceeds, even if the
taxpayer:
- Leaves the proceeds in escrow until the
second property can be acquired
- Has a close relative assist in the
exchange, or
- Has an agent (e.g. Employee, attorney,
broker, etc.) assist in the exchange. This
problem can be solved by the introduction
into the exchange of a professional,
independent, corporate accommodator.
Accommodators offer taxpayers a
comprehensive package or services,
including:
-
Consultation with the
taxpayer on how to structure the
exchange to minimize tax
consequences
-
Document Preparation for
review by taxpayer’s attorney to
facilitate the exchange
-
Accounting of the
transactions including the
annual tax return if necessary
-
Management of Funds to
assist the taxpayer regarding
investment of the exchange
proceeds and, if desired,
coordination with bank trustees.
An accommodater will
help you with
-
Reverse Exchanges
when you purchase
replacement property
before your
relinquished
property can be sold
-
Construction
Exchanges - when
you want to
construct your
replacement property
-
Installment Notes
- when the
exchange includes a
trust deed note or
real estate contract
from the sale of the
relinquished
property
-
Other Types of
Exchanges -
equipment exchanges,
exchanges involving
allocations of
business use
property from a
personal residence
such as a farm and
exchanges crossing
state lines.
Gene Snippen
specializes in 1031
Tax-Deferred
Exchanges. Contact
him for complete
information on how a
1031 Exchange can
work for you.
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