Re Journal Guide
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by: legal1031
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An IRC §1031 tax deferred exchange allows owners of real estate or personal property to defer the recognition of a capital gains tax they would have recognized when they sold their property. Instead of paying a capital gain tax to the government an investor is allowed to use that money toward the purchase of a new property. Tax deferred exchanges are not new – they have been available in one form or another since 1921, and in its current format since 1986.
For example, if an investor sells and office building for $1M, and has a $100,000 capital gain tax due, they would only have $900,000 to reinvest in a new property. By structuring that same transaction as an exchange the investor will have the full $1M to reinvest into another property.
Simply put, an exchange is a sale, just like any other sale, and a purchase, just like any other purchase, but with the inclusion of a qualified intermediary to structure the transactions as an exchange. The qualified intermediary’s role is to prepare the exchange agreement necessary to have a valid exchange, and act as the independent escrow agent to hold the net proceeds from the exchange. A qualified intermediary can also be an invaluable source of information, but they may not give tax or legal advice. Accordingly, a qualified intermediary works with your attorney and accountant and does not replace them.
In order to have a valid exchange it is important to remember that the property being sold and the property being purchase must both be “like-kind” to each other. The concept of “like-kind” is less restrictive than most people realize. It simply means property that is held for use in a trade or business, or for investment purposes. Thus you can exchange any type of property, be it commercial, industrial, residential, retail, or vacant land, for any other type of property, so long as it is held for business or investment property.
Generally excluded from exchange treatment is non-investment property such as a primary residence or vacation home, as well a property held primarily for resale, such as newly acquired or newly constructed property. If the property does not qualify for capital gain tax treatment it generally can not be exchanged.
If an investor is selling “personal property” which is held primarily for investment purposes, such as art work, collectible cars, planes or boats, the term “like-kind” is more restrictive. For personal property the term “like-kind” more closely means a very similar type of property. Thus is an investor was selling a plane used for business or investment purposes they would have to buy an airplane or helicopter. Investors may not exchange between real estate and personal property – they must remain within each class.
When speaking to investors about their real estate holdings it is important to understand both their long-term and short-term goals.
If you are dealing with an investor who is still in his or her prime earning years they are generally interested in building wealth. When an investor states that they will be selling investment property, be it real estate, or personal property held for investment purposes, it is important to find out their goals for the money they will receive upon the sale. If they are using the proceeds from that sale to buy a similar type of property it is a given that the transaction should be structured as a 1031 exchange.
A big draw for investors is to exchange out of a management intensive property, such as an apartment building, into a low or no-management property such as a TIC investment or net-lease. These types of properties provide ownership of real estate, zero management, and a nice return on investment. TIC investments are a partial ownership in large professionally managed property. Because of their structure they are sold almost exclusively as a security through brokers although they are considered real estate for 1031 exchange purposes.
Other scenarios that may indicate that an investor could benefit from a 1031 exchange are as follows:
• Investor is retiring and selling a business which owns real estate, such as a car wash, restaurant, etc.
• Investor is expanding a business which owns real estate or large personal property items, such as trucks, construction equipment, or expensive medial equipment.
• Investor owns management intensive property, such as a residential apartment complex, and wants more free time.
• Investor is unhappy with the returns on existing property and is looking for new investments.
• Investor is planning his or her estate and would like to consolidate various real estate holdings.
The last item to consider when preparing to structure a 1031 exchange is your choice of a qualified intermediary. An investor should consider, among other things, the experience of the qualified intermediary, the security of the exchange funds, and the level of customer service. Always ask to see a biography of the principals of the company to confirm that they have sufficient tax, legal, and real estate experience to properly handle your exchange. Always ask how the exchange funds will be held by the qualified intermediary. The exchange funds should be held in segregated escrow or trust account and backed by a fidelity bond in excess of the amount being deposited.
When properly structured a 1031 exchange is a powerful tool for real estate investors. Taking the time to structure the transaction and working with an experienced qualified intermediary are the keys to success.
Legal 1031 Exchange Services, Inc.
877/701-1031
todd@legal1031.com
About the Author
Legal 1031 Exchanges Services, Inc is the premier National Qualified Intermediary for IRC §1031 tax deferred exchanges. What is a 1031? Learn how Legal 1031 Exchanges Services work and how to protect your real estate investment assets.
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