The document discusses IRS 1031 exchanges, which allow real estate investors to defer capital gains taxes when selling investment properties and reinvesting the proceeds. It explains that a 1031 exchange involves identifying and purchasing a replacement property within strict timelines. Using a qualified intermediary is required to receive sale proceeds and complete the exchange. The document provides an example of how an exchange works and alternatives like a reverse exchange or exchanging into a REIT when suitable replacement properties cannot be found quickly. It stresses seeking tax advice when considering 1031 exchanges.

1. R24 WINE COUNTRY REAL ESTATE • SUNDAY,AUGUST 2, 2015
Mike Kelly
Office: 707-206-4507
Mobile: 707-322-8503
BRE#0645724
Keller Williams
120 Stony Road, Santa Rosa, 95401
TheRealEstateHourBlog.com
email: mike@mikekelly.com
One of Sonoma County’s Natural Resources
Protecting Real Estate Equity: Is IRS 1031 Right for You? (Part I)
By Mike Kelly, Keller Williams Real Estate
Real estate investors often ask if they should
sell and take a capital gains hit (which can be
substantial,) or exchange out of their income/
investment property into a more lucrative real
estate position. It depends! If there is a need
for “cash” and you can afford to take the big
hit of capital gains then by all means consider
selling and using your cash as needed.
However, if you wish to build long-term
wealth, using the IRS 1031 Exchange
is a fabulous vehicle to see your equity
grow. (Check with your tax professional
on all financial matters regarding
capital gains and the right steps for tax
avoidance.)
Using a 1031 exchange does not
eliminate your taxes but defers them
far into the future. You can use the
proceeds of the sale of the investment
property to buy more “like-kind”
investments. We won’t go into all
the myriad details as to what can be
exchanged in this IRS code. (Again,
definitely talk to your tax pro.) The
key is the property proceeds must be
used to acquire “like-kind” investment
properties; a small rental can be
exchanged into land, commercial,
multiple units, etc.
Retiring boomer investors thinking of
gradually liquidating their holdings need
smart tax strategies. When investors say they
don’t mind paying capital gains taxes we
ask them how long would it take to save
the money they’ll be paying Uncle Sam. Not
“earning” but “saving.” This makes every
investor pause and re-think their strategy.
One strategy of a 1031 Exchange is to
back-track your investment strategy. Say you
owned single family homes over the years and
exchanged into a duplex, then to a 4-plex,
next a small apartment building. You have
big equity through appreciation and loan
payoff and are thinking how to get to “cash”.
Some back-track and exchange into many
single family dwellings. For tax purposes this
might be a smoother transition for your heirs.
Instead of leaving a large property which will
have to be sold, you can leave a child one of
the single family houses. This avoids clashing
siblings as one will want to hold and one
will want to sell. Also, if you now have say,
five single-family homes, you may wish to
sell your big primary residence and take your
$500,000 tax deferred home sale and then
move into one of your investment properties.
Live there two out of the five years and sell
and take your big tax deferral again.
A 1031 Exchange is a fairly straight forward
process. It does have some tricky timelines
and, in this highly constrained listing market,
can be very difficult to pull off. You need
cooperative buyers of your “relinquished”
property and know the timelines associated
with a successful 1031 Tax Deferred
Exchange. The time-line begins when
you close escrow on the property you are
exchanging “out of.” Once you close you have
180 days to complete the exchange but within
that 180 days runs the 45 day “identification”
period. You absolutely must identify your
move up property midnight of the 45th day. If
not—not-so-happy capital gains to you.
Many investors wish to exchange up and
are seeking the elusive 10 to 20 units here
in Sonoma County. They are shocked when
they go looking only to find the well dry for
this type of property. When selling
you should be able to negotiate a long
term escrow in which to identify your
move up property. Remember, you
can exchange into a commercial strip
center, office building, land, etc., as
long as it is held for investment and it
can be anywhere in the U.S.
Keep in mind the 45 days is for
identification only, and doesn’t mean
you need to close on the deal. Also,
you’ll need a “qualified intermediary”
to hold your sale proceeds. The
1031 Exchange prohibits you from
personally receiving the proceeds
of your exchange. Hence the reason
for the intermediary receiving sales
proceeds and not you. Be very careful
and do your research! I had a client
who got some horrible advice from her
accountant and took her proceeds and
placed them in a savings account. He told
her it was okay since she wasn’t using the
money while in the process of the exchange.
Absolutely killed the deal for the tax-deferred
nature of the exchange.
In Part II, we’ll review how you can use
the IRS 1031 for big tax savings and equity
build up. I’ll explore how the Qualified
Intermediary or QI works, advantages and
disadvantages of the 1031 and how you can
even exchange into a REIT or Real Estate
Investment Trust. And as always—talk to your
tax professional.
Mike Kelly
Office: 707-206-4507
Mobile: 707-322-8503
BRE#0645724
Keller Williams
120 Stony Road, Santa Rosa, 95401
TheRealEstateHourBlog.com
email: mike@mikekelly.com
One of Sonoma County’s Natural Resources
Protecting Real Estate Equity: Is IRS 1031 Right for You? (Part I)
By Mike Kelly, Keller Williams Real Estate
Real estate investors often ask if they should
sell and take a capital gains hit (which can be
substantial,) or exchange out of their income/
investment property into a more lucrative real
estate position. It depends! If there is a need
for “cash” and you can afford to take the big
hit of capital gains then by all means consider
selling and using your cash as needed.
However, if you wish to build long-term
wealth, using the IRS 1031 Exchange
is a fabulous vehicle to see your equity
grow. (Check with your tax professional
on all financial matters regarding
capital gains and the right steps for tax
avoidance.)
Using a 1031 exchange does not
eliminate your taxes but defers them
far into the future. You can use the
proceeds of the sale of the investment
property to buy more “like-kind”
investments. We won’t go into all
the myriad details as to what can be
exchanged in this IRS code. (Again,
definitely talk to your tax pro.) The
key is the property proceeds must be
used to acquire “like-kind” investment
properties; a small rental can be
exchanged into land, commercial,
multiple units, etc.
Retiring boomer investors thinking of
gradually liquidating their holdings need
smart tax strategies. When investors say they
don’t mind paying capital gains taxes we
ask them how long would it take to save
the money they’ll be paying Uncle Sam. Not
“earning” but “saving.” This makes every
investor pause and re-think their strategy.
One strategy of a 1031 Exchange is to
back-track your investment strategy. Say you
owned single family homes over the years and
exchanged into a duplex, then to a 4-plex,
next a small apartment building. You have
big equity through appreciation and loan
payoff and are thinking how to get to “cash”.
Some back-track and exchange into many
single family dwellings. For tax purposes this
might be a smoother transition for your heirs.
Instead of leaving a large property which will
have to be sold, you can leave a child one of
the single family houses. This avoids clashing
siblings as one will want to hold and one
will want to sell. Also, if you now have say,
five single-family homes, you may wish to
sell your big primary residence and take your
$500,000 tax deferred home sale and then
move into one of your investment properties.
Live there two out of the five years and sell
and take your big tax deferral again.
A 1031 Exchange is a fairly straight forward
process. It does have some tricky timelines
and, in this highly constrained listing market,
can be very difficult to pull off. You need
cooperative buyers of your “relinquished”
property and know the timelines associated
with a successful 1031 Tax Deferred
Exchange. The time-line begins when
you close escrow on the property you are
exchanging “out of.” Once you close you have
180 days to complete the exchange but within
that 180 days runs the 45 day “identification”
period. You absolutely must identify your
move up property midnight of the 45th day. If
not—not-so-happy capital gains to you.
Many investors wish to exchange up and
are seeking the elusive 10 to 20 units here
in Sonoma County. They are shocked when
they go looking only to find the well dry for
this type of property. When selling
you should be able to negotiate a long
term escrow in which to identify your
move up property. Remember, you
can exchange into a commercial strip
center, office building, land, etc., as
long as it is held for investment and it
can be anywhere in the U.S.
Keep in mind the 45 days is for
identification only, and doesn’t mean
you need to close on the deal. Also,
you’ll need a “qualified intermediary”
to hold your sale proceeds. The
1031 Exchange prohibits you from
personally receiving the proceeds
of your exchange. Hence the reason
for the intermediary receiving sales
proceeds and not you. Be very careful
and do your research! I had a client
who got some horrible advice from her
accountant and took her proceeds and
placed them in a savings account. He told
her it was okay since she wasn’t using the
money while in the process of the exchange.
Absolutely killed the deal for the tax-deferred
nature of the exchange.
In Part II, we’ll review how you can use
the IRS 1031 for big tax savings and equity
build up. I’ll explore how the Qualified
Intermediary or QI works, advantages and
disadvantages of the 1031 and how you can
even exchange into a REIT or Real Estate
Investment Trust. And as always—talk to your
tax professional.
Protecting Real Estate Equity: Is IRS 1031 Right for You? (Part II)
By Mike Kelly, Keller Williams Real Estate
As real estate equity makes a big comeback
due to surging home prices, we are seeing more
and more investors opting to sell their investment
properties and “move” their equity into another
investment opportunity.
In the first part of this two part column on 1031
Exchanges, we discussed how this is done and
why it is a big benefit to any investor wanting to
increase their real estate portfolio. A quick
recap: a 1031 Tax Deferred Exchange allows
an investor to take equity from one property
and “exchange” it into another. What is the
reason the tax is deferred instead of actually
paid? No funds are received by the investor.
Receipt of funds is forbidden by the investor
and is one of the essentials to a tax-deferred
exchange.
Here’s a typical 1031 exchange scenario:
1. Investor decides to sell an investment
property through a 1031 exchange. S/he will
contact a Qualified Intermediary (QI), enter-
ing into an agreement. Remember, investor
cannot be in receipt of the proceeds after the
close—the QI will “hold” these funds.
2. Investment property is put on the market.
3. Offer(s) to purchase the investment proper-
ty is accepted and signed by the QI.
4. Escrow for the sale is opened, and a pre-
liminary title report is produced.
5. QI sends required exchange documents to es-
crow for signing at property closing.
6. Escrow closes.
7. Within the first 45 days after the close of escrow
on the sale of the relinquished property, the inves-
tor identifies replacement properties as required
by law. This is known as the “Identification Peri-
od”.
8. Within 180 days after the close of escrow on the
sale of the relinquished property, the investor clos-
es on one of the replacement properties which he
has identified. This is called the “Exchange Period”.
This completes the exchange. Remember, the 45
days runs “within” the 180 days.
What is a Qualified Intermediary?
A Qualified Intermediary (QI) is the company or
party who holds the funds until needed to close the
escrow of the “move-up” property. Many title com-
panies have an exchange service as do private firms.
Go with a major player in the QI field. Remember,
the tax payer or “exchanger” cannot have access or
control over the funds realized from the sale of the
“relinquished” or original property in the exchange.
The QI will receive funds from the escrow and hold
the funds until needed to complete the exchange.
The QI sends the proceeds to the new escrow on the
“move-up” property, it closes and then the taxpayer
or “exchanger” becomes the owner.
Remember the key: taxpayer or exchanger cannot
have “constructive receipt” of the funds. You violate
this fundamental rule and your exchange becomes
just a sale with inherent tax liabilities. Contact your
tax attorney, CPA or accountant, who knows the ins
and outs of conducting a tax deferred exchange.
Sounds fairly straight forward, right? However,
some big wrenches can get thrown into the works of
an exchange. The biggest problem can be finding the
“move-up” property within the 45 identification peri-
od. With super tight inventory across all investment
fields, finding the elusive other “leg” of the ex-
change could blow the whole deal. Enter the “re-
verse exchange.” Those opting to use the “reverse
exchange” do so to avoid the dreaded time-lines
for a normal exchange. It is much easier to find
the “move-up” property without all the pressure of
the timeliness of a normal exchange. Or perhaps
an enticing investment opportunity comes along
and you have little time to prepare and sell your
“relinquished” property? These scenarios make a
“reverse exchange” worth the effort.
Remember, the rule of an exchange is not
to have “constructive receipt” of the funds
from the sale of an exchanged property. In a
Reverse 1031 Exchange the property you are
buying cannot be in your name, no construc-
tive receipt” of ownership and is “owned” by
and in the name of the “exchange accommo-
dator.” Your QI can arrange this service also.
Once again, this complicated strategy should
be thoroughly investigated before attempting
to purchase the “move-up” property. Re-
member, receipt of sales proceeds or in this
case, title to the “move-up” property without
completing the exchange is a big no-no. The
issues compounds when you realize the “ex-
change accommodator” will be holding title
to the property and your lender is qualifying
you for the loan. You need to make sure your
lender is able to perform with this restriction.
It is highly advisable to explore the ramifications
and qualifications of using a “reverse exchange”
with your lender of choice and keep them in the
loop on all steps of the exchange.
Lastly, you can “exchange” into an upREIT or
“Umbrella Partnership Real Estate Investment
Trust”. An upREIT is a “securities” based invest-
ment vehicle with many properties in its portfolio.
It needs a very precise set of steps to achieve.
It’s not for all investors and is an alternative to
explore. Downside? You can’t exchange out of an
upREIT. It has its benefits and should be explored
by certain investors. As always, talk to your real es-
tate tax professionals before attempting any of the
exchanges discussed in this column.
Issue Date: ro/sa/