1031’s Blog

A Secret To 1031 Like Kind Exchanges

The 1031 Exchange process starts with your CPA or accountant. The discussion should include the amount of taxes owed if you sold the property outright. The adjusted basis would be determined, and based on this adjusted basis, you can determine what the “normal” capital gains tax liability would be. Also, you can determine the amount of taxes that would be due to depreciation recapture. This depreciation recapture is currently taxed at a maximum rate of 25%. The capital gains that are attributed to depreciation are taxed at a higher rate.

Likewise, your CPA or accountant will determine how much of the gain relates to normal appreciation from the natural increase in the value of the property. This appreciation is currently taxed at a maximum rate of only 15%. Your CPA will also determine if any state income tax or capital gains tax would be incurred. This would also include municipal tax liability.

Once all of the tax liabilities have been determined, an informed decision can be made as to whether to sell the property outright or to utilize the benefits of a 1031 Exchange. Typically, the cost of doing a 1031 Exchange is far less than the tax bill if you just sold the property outright.

The first step in taking advantage of a 1031 Exchange is to contact a Qualified Intermediary. The Qualified Intermediary will advise you of the need for a written purchase agreement signed by you as the seller and your purchaser. This agreement establishes your desire to sell your relinquished property as part of a 1031 Exchange.

In addition, it is a good idea to add a stipulation or clause in the purchase agreement stating that you want to complete a 1031 Exchange with regards to the property and that the purchaser agrees to cooperate with such. You have now laid the basic groundwork for the closing. For sample cooperation clause go to www.1031podcast.com.

At the closing, the sale will become complete. The deed crosses the desk to the purchaser, and the net sales proceeds are paid directly to the Qualified Intermediary. This starts the 1031 countdown. The day after the closing is considered “day one” in the forty-five day identification period. During the forty-five days, you must identify in writing the property that you want to purchase as your replacement property. This “day one” is also the start of the 180 day exchange period that you have to complete the 1031 exchange and acquire your replacement property.

In summary, the first step is to work with your CPA or accountant to determine what the capital gains tax will be (including depreciation recapture and state and local taxes.) At this point, you will decide if the 1031 Exchange will be of benefit to you. A Qualified Intermediary can help you and your CPA or accountant realize the full potential of the 1031 Exchange process. The next step is to document your intent to sell the property to your purchaser as well as your desire to complete a 1031 Exchange by inserting text in your purchase agreement.

If you have all of these things done, you can start the processes of deferring taxes and keeping your money working for you.

U.S. investors can save a lot of money by using a 1031 exchange to defer all of their capital gains tax on the sale of investment property. A 1031 tax exchange is similar to an interest free loan from Uncle Sam.

Exchange Your Debt With A 1031 Tax Exchange

The basic premise behind a 1031 exchange is that that you, the taxpayer, are shifting all of your equity from one property to the next. In effect, the old debt is being offset by the new debt on the replacement property. However, there are two ways to usurp this premise and cash out some of your equity: pre-exchange refinancing, and post-exchange refinancing. Pre-exchange financing will be discussed first.

In a 1031 exchange, all the proceeds from the sale are supposed to be passed on to the Qualified Intermediary - this prevents you from receiving any cash benefit from the sale. There may be times, however, when you would like to use some of that money for other purposes. If you decide to refinance your property shortly before the 1031 exchange and use that equity for your desired luxury item, you may find yourself violating IRS rules. (IRS vs. Garcia)

We have tax case IRS versus Garcia which tells us that the refinance must be done well prior to the 1031 Exchange. Garcia tried to avoid taxes and ran afoul of the 1031 rationale and the IRS. He ran into problems because he refinanced just before the 1031 Exchange and tried to take proceeds without paying the taxes. Therefore, you can’t take out equity unless you pay taxes on it.

Now, you want to avoid the Garcia issue so you decide to refinance the replacement property. This is where post-exchange financing comes into play. Not all taxpayers want to leave their equity in the replacement property - some want to take out that equity and buy more real estate. But, how long should you wait after completing the 1031 exchange before you take out the equity in the replacement property? Some say wait a nanosecond.

There is debate on how long one must wait after the 1031 exchange to show the IRS, through the closing statement, that you have invested all of your equity into the replacement property. Some say wait a nanosecond to establish a separate transaction and a new settlement statement to show that the replacement property was encumbered with new debt via a loan or a mortgage. Once this is established, there is a cash payment from the lender to you. Essentially, you have tapped into a pool of money made available through the 1031 exchange.

The legality of the nanosecond exchange is debatable. There are risks because there is no definitive IRS rule regarding how long you are to keep the equity in the replacement property. A more prudent approach would be to keep the money in the replacement property in order to avoid the Garcia trap. In this case, keep the equity in the replacement property until the following tax year or until two years have passed from the 1031 exchange to the ultimate finance.

U.S. investors can save a lot of money by using 1031 tax exchanges to defer all of their capital gains tax on the sale of investment property. 1031 exchanges are like an interest free loan from the IRS.

Why You Don’t Have To Pay Your Capital Gains Taxes

Many investors make the mistake of selling their business or investment property and end up having to pay thousands of dollars to the government in capital gains taxes. What they may not know that there are tax laws that provide them the ability to defer all of the capital gains taxes on the sale of property which has been held as a trade or business - thereby retaining their gain.

This law defers and can even eradicate taxes you would normally have to pay if you were selling your property. However, the money you make from selling your property must be used exclusively to purchase a like-kind property that you also intend to use for business or investment purposes.

When you take advantage of the 1031 exchange laws, you can save a lot of money, thereby allowing you to leverage your equity by purchasing even more property (which may have not been possible without the added tax savings).

The 1031 Exchange provision has saved investors millions and millions of dollars, and it is well worth your time to explore the benefits of it for yourself. In order to reap those rewards, there are some specific procedures you need to follow.

Be sure that you select qualified intermediary (A.K.A. “Q.I.”) with a solid track record and professional reputation. Dealing exclusively with doing 1031 exchanges, a Qualified Intermediary is an expert with the facilitation of such a deal.

Your Q.I. provides a written agreement to change the transfer from and outright sale to an “Exchange” then transfers your relinquished property (that you are selling) and takes that money and uses it to purchase your replacement property on your behalf.

You must abide by the following 1031 rules to qualify for an exchange:

1. Firstly, the investment property that you are replacing must have been used for investment purposes or use in a trade or business and must be “like-kind” (i.e. real estate in the United States for real estate in the U.S.).

2. Secondarily, you will need to locate a property to replace your property if you have not yet done so, and make sure it is identified clearly in writing within 45 days to your Qualified Intermediary. It is necessary to close on the sale on the replacement property within one 180 days.

3. To defer your capital gains taxes, all of the proceeds from the sale of the first property must be used to purchase your new replacement property.

Follow these 1031 rules and you will be in the best position to faciliate your exchange. The steps are very simple and even if the road along the way gets a little complicated, in the end it will put a big smile on your face. Do something good for yourself by retaining your capital gains with a 1031 Tax Exchange!

Investors in the U.S. can save big money by using a 1031 exchange to defer all of their capital gains tax on the sale of investment property. A 1031 tax exchange is like an interest free loan from Uncle Sam.

Watch the video on 1031 exchange rules to learn more.

What Investors Need To Know About 1031 Exchanges Fees

The general rule when it comes to 1031 exchanges is that all proceeds from the sale must be reinvested in the replacement property, but as a property investor you likely have experience with the other costs associated with closing on a sale, including your real estate agent’s commission, the recording of the deed, and know that some of your proceeds must be put towards these sorts of transactional expenses.

But what about expenses that don’t necessarily fit into your typical closing statement, a classic example of which being rent proration and security deposits on the sale of a relinquished property?

The correct way to go about transferring future rent and security deposits to the new owner of the property is to cut a check from your own expense account. If you debit these kinds of expenses to your closings statement, you are effectively freeing money in your account for your own use and taking what as known as boot from the proceeds of the transaction. Any cash benefit or boot you receive from the sale is not considered part of a like-kind exchange, and investors who have attempted this have found themselves facing IRS litigation.

Section 1031 operates under the assumption that the investor is transferring the entirety of the equity on the sale property to the replacement. It is unacceptable to debit expenses such as rent proration or security deposits to the closing statement as that frees money in your operating account for your use. Any cash benefits or proceeds that you receive in this context are referred to as boot, and because they are not part of a like-kind exchange are taxable.

The fact of the matter is that the IRS examines these sorts of transactions, and will not look kindly on your receiving non-like-kind proceeds or cash benefits from 1031 transactions. With this in mind, you should be wary and take care regarding what expenses end up on your closing statement.

United States property investors can save big money by using a 1031 exchange to defer all of their capital gains tax on the sale of investment property. A 1031 tax exchange is almost like getting an interest free loan from Uncle Sam!