1031 Tax Deferred Exchange

Do you own appreciated real estate that you are considering selling but wish to avoid the burden of capital gains taxes? Learn how tax-efficient strategies like utilizing 1031 exchanges and DST investments can work for you.

WHAT IS IT?

A properly structured §1031 Tax Deferred Exchange allows an investor to sell a property, reinvest the proceeds into a new property and defer all capital gain taxes. As long as the type of property being exchanged is like-kind, this can be done with any investment real estate – for example, vacant land can be exchanged for rental property. In addition, it is often possible to exchange one property into multiple properties. The three property rule allows for an exchange into three separate properties which can provide for diversification of capital. In most cases, one’s personal residence is not a like-kind investment property. Some types of properties considered like-kind properties are commercial buildings, rental income properties, land, multi-family properties, grocery anchors and retail centers.

EXCHANGING UP

To accomplish a fully tax-deferred exchange the rule of thumb is… exchange even or up in value and exchange even or up in equity and in debt.

BOOT

To the extent that one does not exchange even or up in equity and debt, one will have received non-qualifying property (“boot”) in your exchange. If boot is received, tax is computed on the amount of gain on the sale or the amount of boot received – whichever is lower.

TYPICAL EXCHANGE ADDENDUM LANGUAGE FOR SALES CONTRACTS

“Buyer hereby acknowledges that it is the intent of the Seller to effect an IRC §1031 tax deferred exchange which will not delay the closing or cause additional expenses to the Buyer. The Seller’s rights under this agreement may be assigned to a Qualified Intermediary, named by Seller, for the purpose of completing such an exchange. Buyer agrees to cooperate with the Seller and the Qualified Intermediary in a manner necessary to complete the Exchange.”

HOW DOES IT WORK?

1031 DO’S & Don’TS

1031 DO’S

DO advance planning for the exchange. Talk to your accountant, attorney, financial planner, lender and Qualified Intermediary prior to exchanging and possibly investing in a DST

DO keep in mind these three basic rules to qualify for a complete tax deferral:

  • Receive only “like-kind” replacement property

  • Use all proceeds from the relinquished property for purchasing the replacement property

  • Make sure the debt on the replacement property is equal to or greater than the debt on the relinquished property. (Exception: A reduction in debt can be offset with additional cash; however a reduction in equity cannot be offset by increasing debt.)

DO attempt to sell before you purchase. Occasionally exchangers find the ideal replacement property before a buyer is found for the relinquished property. If this situation occurs, a “reverse” exchange (buying before selling) may be necessary.

1031 DON’TS

DO NOT miss your identification and exchange deadlines. Failure to identify within the 45 day identification period or failure to acquire replacement property within the 180 day exchange period will disqualify the entire exchange, resulting in the sale of downleg property being fully taxable. Reputable Intermediaries will not act on back-dated or late identifications.

DO NOT try doing a 1031 exchange using your attorney or CPA to hold title or funds. IRS regulation requires Qualified Intermediary to properly complete an exchange.

DO NOT dissolve partnerships or change the manner of holding title during the exchange. A change in the Exchanger’s legal relationship with the property may jeopardize the exchange.