re-invest your equity

TAKE FULL ADVANTAGE OF THE 1031 EXCHANGE PROGRAM

A 1031 exchange allows real estate owners to defer capital gains tax from the sale of a property when purchasing another. Meaning you can sell a real estate property for another piece of property (for example, you can sell a condo and buy a shopping mall – or vice versa – without incurring capital gains taxes). 1031 allows real estate owners to exchange several properties for one. There are many reasons why real estate investors might be examining their holdings. Opportunities abound. And in order to profit from them, it’s critical to know all about Internal Revenue Code Section 1031.

A Sale vs. an Exchange

Net Equity	$300,000	vs	Net Equity	$300,000
Capital Gain Tax	$100,000	vs	Capital Gain Tax	$0
Equity to Reinvest	$200,000	vs	Equity to Reinvest	$300,000

Every dollar saved in taxes allows an investor to purchase substantially more real estate. To illustrate the value of an exchange versus a sale, assume the following: An investor sells a fully depreciated property with no debt. The capital gain is $300,000 and the combined federal and state tax rate is 33%.

What is a 1031 Exchange?

Section1031, of the Internal Revenue Code offers real estate investors one of the last great investment opportunities to build wealth and save taxes. By completing an exchange, the investor (Exchanger) can sell an investment property, use all of the equity to acquire replacement investment property, defer the capital gain tax that would ordinarily be paid, and leverage all of their equity into the replacement property. Two requirements must be met to defer the capital gain tax: (a) the Exchanger must acquire like-kind replacement property and (b) the Exchanger cannot receive cash (unless the Exchanger pays capital gain taxes on this money). Investors can accomplish virtually any investment objective with exchanges including greater leverage, diversification, freedom from joint ownership, improved cash flow, geographic relocation and/or property consolidation.

EXCHANGE BASICS

What is Involved in a Exchange?

A typical tax deferred exchange is very similar to a taxable transaction except that prior to closing on the property being sold, a Qualified Intermediary is assigned into the Sale Contract then sells the property to the buyer and transfers the proceeds safely into a separate exchange account. The exchange period begins with the transfer of the first property providing the investor 45 days to identify several new investments (like-kind" replacement properties) and a total of 180 days to close the ones of choice. The exchange is completed when the seller is assigned into the Purchase Contract, utilizes the proceeds received to acquire the replacement property, and instructs the closer to transfer ownership to the exchanger via direct deeding.

What are the Exchange Requirements?

Purchase equal or greater value.
Reinvest all net equity.
Equal or greater debt. (no net loan relief)

Exchanges must be completed within strict time limits. The Exchanger has 45 days from the date the relinquished property closes to identify potential replacement properties. This involves a written notification to the Qualified Intermediary listing the addresses or legal descriptions of the potential replacement properties. The purchase of the replacement property must be completed within 180 days after of the close of the relinquished property. After the 45 days has passed, the Exchanger may not change their Property Identification list and must purchase one of the listed replacement properties or the exchange fails!

To avoid the payment of capital gain taxes the Exchanger should follow three general rules: (a) purchase a replacement property that is the same or greater value as the relinquished property, (b) reinvest all of the exchange equity into the replacement property, and (c) obtain the same or greater debt on the replacement property as on the relinquished property. The Exchanger can offset the amount of debt obtained on the replacement property by putting the equivalent amount of additional cash into the exchange.

Taxes are Paid on Capital Gain, not Equity or Profit."

It is possible to have little or no equity and still owe tax. Capital gain is arrived at by subtracting the adjusted basis from the adjusted sale price. The adjusted sale price is the gross sale price minus standard transaction costs. There are a number of components used to arrive at the adjusted basis. First, establish the original basis (usually the original purchase price). Next, add to this figure all improvements made to the property which were not expensed. Then, subtract all depreciation taken over the period of ownership.

To determine the estimated capital gain, subtract the adjusted basis from the sale price. Next, subtract the transaction costs (commissions, fees, etc.) to determine the capital gain. Finally, multiply the capital gain by your combined tax rate (Federal and State) to determine your estimated capital gains tax.

FREQUENTLY ASKED QUESTIONS

Q. What is a 1031 tax-deferred exchange?

It is a method allowed by Internal Revenue Code Section 1031, whereby owners of certain property may sell such property and not pay any capital gains taxes on such sale if such owners buy certain new property within a specified time period.

Q. What types of property qualify for a 1031 exchange?

Any property held for productive use in a trade or business or property held for investment purposes can be exchanged for any like-kind property; property may be real or tangible personal property such as an apartment building, raw land, single family rental, shopping center, 30 year or more leasehold interest or equipment; like- kind property refers to the nature of the property (i.e. held for use in a business or for investment) not the use of the property – so a shopping center may be exchanged for an apartment building or an apartment building may be exchanged for raw land; furthermore, one property can be sold and three properties acquired; or four properties can be sold and one acquired.

Q. What types of property do not qualify for a 1031 exchange?

Stocks, bonds, partnership or LLC interests, personal residences and stock in trade or inventory.

Q. Are there any time restrictions to complete a 1031 exchange?

Yes. Once you have sold the relinquished property, you have 45 days from the date of such sale to identify the replacement property and 180 days from the date of such sale to close on all of the replacement property.

Q. What are the guidelines in order to defer all taxable gain?

The four basic guidelines for an exchange are (1) the replacement property must be equal to or greater in value than the relinquished property; (2) the equity in the replacement property must be equal to or greater than the equity in the relinquished property; (3) the replacement property must be encumbered by equal or greater debt than the relinquished property; and (4) all net proceeds must be used in acquiring replacement property.

Q. What is a qualified intermediary and why do I need one?

A qualified intermediary is a neutral party who facilitates the exchange of the relinquished property and the acquisition of the replacement property by having such sale and acquisition flow through the qualified intermediary and by providing proper documentation to preserve the integrity of the transaction. Furthermore, the qualified intermediary safeguards the proceeds from the sale of the relinquished property and transfers such proceeds either to (i) the seller of the replacement property or (ii) back to the initial owner if a replacement property is not identified within 45 days or a replacement property is not closed on within 180 days.

Q. What happens to my money while I look for a "Replacement Property"?

Your funds are deposited into an interest bearing joint trust account.

Q. What if I cannot identify a replacement property within 45 days or close on a replacement property within 180 days?

The proceeds from the sale of the relinquished property will be sent to you immediately. Please note that you would have to pay any taxes arising from the sale.

Q. Do I have to hold the replacement property for a period of time?

The IRS, as yet, has not set a specific time requirement for holding replacement property. However, the holding period must be long enough to show there was intent to hold such property for investment or use in a trade or business.

Q. Can I buy replacement property from or sell my relinquished property to a related party?

Yes, but the Code requires you to hold the replacement property and the related party not to sell the relinquished property for two years. Furthermore, there are a number of additional complex rules regarding related parties as they pertain to partnerships, corporations and trusts.

We cannot provide advice regarding specific tax consequences. Investors considering an IRC 1031 tax deferred exchange should seek the counsel of their accountant and attorney to obtain professional and legal advice.