2. What is a 1031
Tax Deferred Exchange?
The code allows you to sell (Relinquished Property) one or more
Investment properties and buy (Replacement Property) one or more
properties through a Qualified Intermediary (QI). The seller
cannot touch or control the funds.
The QI documents must be signed prior to closing of the
Investment property being sold.
The property can be anywhere in the US.
3. Property sold and purchased must
be property held as an Investment
property.
Most CPAโs say 2 years would probably survive an audit,
however, many accountants and CPAโs say 2 years means
a year and a day or being on your tax return the last 6
months of one year and the lst 6 months of another year.
Clients must act on the advise of their Tax Preparer.
4. The basic rules if your client does not want
to pay any capital gains tax are as follows:
โข Buy property sale price to sale price equal or greater
โข Put a Mtg./loan on the new equal to the balance of the
Mtg./loan on the old or greater as long as you donโt
pull cash out.
โข All the cash from the sale into the purchase
โข Come into title as title was held on the property sold.
If you buy down or have a Mtg/loan for less there will be tax consequences. Client
must consult with their Tax Preparer to determine amount of tax.
5. Like for like means Investment for Investment. Vacant
land for rental house, rental house for Apt. building, Apt.
Building for commercial, industrial etc.
Exchange
โข For Property with More Cash Flow
โข To Increase Appreciation Potential
โข To Change your Depreciable Base
โข To Reduce Risk
โข For Asset Simplification
โข To Multiply Your Investment
โข To Delay Recapture
6. Partial Exchange:
Multi-family property with owner living in
one of the units.
Determine percentage value of Investment
portion (consult with tax preparer) and
claim the Primary Residence Exclusion on
the balance.
7. Rules To Identify
Replacement Property
The General Rule For Replacement Property.
Sale price is equal to or greater than relinquished property.
What Are The IRS Identification Rules?
Three Property Rule - The Exchanger may identify three (3) properties of any value;
or
200% Rule - The Exchanger may identify any number of properties if the total fair
market value of what is identified does not exceed 200% of the sale price of the
relinquished property; or
95% Rule - If the Exchanger identifies more properties than are permitted under the two
rules above, the Exchanger must acquire 95% of what was identified.
8. How Is The Identification Made?
1.The identification must be made to a party to the exchange
(i.e., the Qualified Intermediary)
2. Identification must be in writing and signed by exchanger.
(We furnish a form to the taxpayer on close of the relinquished property)
3. The identification must include street address or legal
description.
4. It must be delivered, within 45 days of the close of
relinquished property.
9. IRC 1031 DELAYED EXCHANGE PERIODS
IDENTIFICATION PERIOD:
Begins on the date the taxpayer transfers (closes) the sale of Relinquished Property
and ends at midnight on the 45th day thereafter.
EXCHANGE PERIOD:
Begins on the date the taxpayer transfers (closes) the sale of the Relinquished
Property and ends at midnight of the 180th day. Exchanger must file an extension
on there tax return if replacement property does not close in time to file. There are
are no extensions for the 45th or the 180th day and there are no extensions for
Saturdays, Sundays, or Holidays.
10. ADDITIONAL RULES IN CALCULATING
EXCHANGE PERIODS:
(1) If several Relinquished Properties are to go โinto one Exchangeโโ
the Identification Period and the Exchange Period are determined by
the closing date of the FIRST Relinquished Property.
(2) The Identification Period and Exchange Period are NOT extended to
the next succeeding date if the last day fall on a Saturday, Sunday, or
legal holiday.
(3) Property is treated as close when โlegal titleโ is transferred. โClosingโ
in some States is not necessarily โrecording of the Deedโ.
11. Capital Gains Tax is paid on the Gain
Capital Gains Tax is paid on the Gain
(many people think they pay on Equity)
(many people think they pay on Equity)
$800,000.00 Sale price $800,000.00 Sale price
$200,000.00 Pd. $500,000.00 Loan
$600,000.00 Gain $300,000.00 Equity
In simple terms the CPA will add capital improvements
and deduct depreciation. Sometimes clients have offsetting
capital losses, or suspended losses so it is imperative for
the client to talk with their Tax Preparer for amounts.
12. PRIMARY RESIDENCE EXCLUSION:
$250K for a single person or $500K in gain for
married people or Registered Domestic Partners.
Available on the house you live in every 2 years. If you sell before 2 years you pay tax
unless you are selling for a reason that allows your CPA to prorate.
Exclusion on Second home available if you lived there 2 full years out of the last 5.
On an investment property, that you did a 1031 exchange into, it must have been your
primary residence for 2 out of the last five years and as of Oct. 22, 2004, you must own
the property for 5 years in order to claim your primary residence exclusion.
Please refer clients to the CPA to review the code regarding married individualโs
eligibility, divorced taxpayers, widowed individuals, & hardship relief.
13. Representing the seller of the
Relinquished Property:
Determine on listing if it is a property the seller reports on
their Income Tax Return as an Investment Property.
โSeller may do a 1031 Tax Deferred Exchangeโ in the
Listing Agreement.
IRC 1031 Intent Language in the Real Estate Contract
(Purchase/Sale Agreement)
Ask the closer/settlement agent/attorney/escrow officer to
call us and be sure to call us to call the closer.
14. Representing the buyer of the
Replacement Property:
If the client does not want to pay any Capital Gains Tax what must they buy?
Sale Price must be equal or greater than the sale price on property sold.
How much of a loan do they obtain on the new property?
Loan/Mtg. Must be equal to or greater than the loan/mtg. On the property sold.
How must they take title to the Replacement property?
Title on the new property must be held the same as they held title on the Relinquished
property (property sold).
Must all the cash from the sale go into the purchase?
Yes
If Exchanger buys down or gets a Mtg/Loan for less or pulls cash out what happens?
Exchanger pays capital gains tax per their CPA or Tax Attorney
15. Representing the seller of the
replacement property
You receive an offer that states the buyer is doing a 1031 Tax Deferred
Exchange and your seller agrees to cooperate at no cost or liability to
the seller.
What Questions do you ask?
Has the buyers sale closed or when is it closing?
If not closed, has their buyers loan been approved and are all the contingencies
removed?
If closed, who is the Qualified Intermediary (QI)? You must give the
closer/settlement agent that information.
Ask agent representing the buyer to get you a copy of the buyers closing
statement on their sale.
16. Commercial Building:
Cost Segregation
Separation of the cost of tangible property,
fixtures, air conditioning etcโฆ If cost
segregation was done on the relinquished
property it may be imperative that cost
segregation be done on the replacement
property.
17. Questions and Answers
What real property qualifies for a 1031 Exchange?
Relinquished and replacement properties must be property held for Investment.
What if the replacement property is new construction?
Make sure completion/closing takes place by the 180th day.
What questions would you ask if there is personal property included?
What value are you placing on the personal property?
Should it be separated from the real property?
Is the seller going to give the buyer a โBill of Saleโ?
18. Questions and Answers
Continued
How long do you have to find a Replacement Property?
Identification must be made within 45 days of the closing
date of the relinquished property.
When must the replacement property close?
The replacement property must close within 180
days from the closing of the first relinquished property.
Exchanger must file an extension on their tax return if
replacement property does not close in time to file there
tax return. There are no extensions for Saturdays, Sundays,
or Holidays.
What is โAdjusted Basisโ?
Basis plus capital improvements, less depreciation.
What is Boot?
โBootโ is any excess money or unmatched property coming from the sale.
19. SELLER CARRY BACK;
Note is drawn in favor of QI and assigned to seller of relinquished property
at the end of the exchange period
Payer (buyer of property) pays the note off during the 180 day
exchange period.
Offer the note to the seller of the Replacement property.
Have the note purchased prior to the 180 day exchange period. (If seller has
the money outside of the exchange to loan to the buyer and wants to use that
money thereby taking the note out of the exchange so it is not taxable)
If the note is structured as an Installment sale, tax is paid as the principal is
received and it does not preclude the owner from refinancing and paying the
note off.
20. Important things to have your client
get answers on from their CPA:
Cost of recapturing the depreciation is different on
residential and commercial.
Cost of recapturing depreciation on tangible
personal property
It is imperative that your client seek the advice
of their CPA or Tax Attorney, to determine tax
consequences. Tax may be owed even when the
sale price is less than what they paid after
recapture of depreciation.
