 |
|
|
    |
TAX DEFERRED EXCHANGES
SECTION 1031
- INTERNAL REVENUE CODE
What is it?
A method to trade one real
(real estate) property for another of "like-kind" and defer the tax on any
realized gain until some future time, usually when the newly acquired property
is eventually sold. Commonly referred to as a "tax free exchange". The
transaction must be structured as an actual exchange rather than a sale of one
property and purchase of another.
 Popular
Misconceptions.
Two party exchanges can happen, but rarely occur.
Exchanges usually involve 4 parties - the relinquished property's seller and
buyer, the replacement property's seller, and an intermediary. Properties may
be in different states.
"Like-kind" simply means real property
exchanged for real property. They do not have to be the same type. Also,
subject to certain limitations, one property can be exchanged for more than one
property. Personal property does not qualify.
Closings do not have to
occur simultaneously; however the replacement property must close within 180
days after closing on the relinquished property.
Advantages of
Exchanging.
No immediate tax liability. Seller retains use and earning
power of his tax dollars. Similar to an interest free loan. Benefits can be
increased with subsequent exchanges. The tax liability is forgiven upon death
of the taxpayer which means the estate never has to repay the "loan." In
addition, heirs receive a stepped up basis equal to market value at time of
death.
Disadvantages of Exchanging. Reduced basis in the replacement
property increases gain in event of sale. Transactional (closing) costs are
usually higher than typical straight sale. Net proceeds from the sold property
may not be used for anything except reinvestment in real property.
What is a Deferred or Starker Exchange?
Occurs when seller
of the relinquished property has not selected the replacement property. Seller
then has 45 days from date of sale to identify the replacement property which
still must close within the original 180 days (or due date for federal tax
return including extensions, whichever occurs first). Commonly referred to as
the First Leg (Down Leg) for the sale, and as the Second Leg (Up Leg) for the
purchase.
What is a Reverse Exchange?
A Reverse Exchange
occurs when the purchase of the replacement property takes place in advance of
selling the relinquished property.
Definitions.
Adjusted
Basis -
Original starting point (Basis) plus Capital Improvements less
depreciation taken during period of ownership.
Realized Gain -
Difference between total consideration received for the relinquished property
and the Adjusted Basis.
Recognized Gain - That portion of the
Realized Gain, which is taxable. In a 1031 Exchange, Realized Gain is
Recognized to the extent "Boot" is received. For tax purposes, Recognized Gain
is always limited to the lesser of Realized Gain or Boot. Therefore, for the
tax to be totally deferred, the Replacement Property must have equal or greater
market value and debt than the Relinquished Property, and no Boot received.
Boot - Consideration received other than real property. There
are two types of Boot. "Cash Boot" is cash or anything else of value received.
"Mortgage Boot" is any liabilities assumed or taken subject-to in the exchange.
Cash boot received may be offset by cash boot paid. Same for mortgages, and,
net mortgage boot received may be offset by cash boot paid. However, cash boot
received may not be offset by mortgage boot paid.
Constructive
Receipt - Proceeds from a sale of the relinquished property that are
credited to an account, set apart, or otherwise made available to the taxpayer
are considered to be "constructively" received for tax purposes unless the
taxpayer's control is subject to substantial limitations or restrictions. Use
of a qualified intermediary is crucial.
Intermediary - A straw
party (like a title company) responsible for structuring the exchange,
receiving and transferring title, and facilitating the overall process.
Starker - Not simultaneous. |
 |
|
WEICHERT® COMMERCIAL AFFILIATES
A Division of WEICHERT, REALTORS®-Coastal Properties
(843) 686-6700 · Email
1038 William Hilton Parkway · Hilton Head Island. · SC 29928
22 Plantation Park Drive, Ste. 103 · Bluffton SC · 29910
© All Rights Reserved, WEICHERT, REALTORS®-Coastal Properties
|
|
|
|
|
|