1031
Exchanges: an Overview
1031
Exchanges (or 1031 Like Kind Exchanges): What Are They?
The
Like Kind Exchange is a transaction that involves property held
for productive use in a trade or business or for investment
(except inventory and stocks and bonds) for property of the
same type. Unless different property is received (called boot),
the exchange is nontaxable in the current year. Generally, if
you exchange business or investment property solely for business
or investment property of a like kind, no gain or loss is recognized
under section 1031. Like Kind exchanges are often referred to
as Starker Exchanges, Deferred Exchanges, Land Swaps and Trades.
Discussion in this article is limited to real property, even
though these IRS provisions are also used in many trades or
businesses to trade fleets of equipment such as airliners, trucks,
busses, and so forth.
For
those of you looking for wise investments in real estate, the
Asheville area, the hottest market for second/vacation homes
in the USA, could top your list! And, with just a little planning,
the 1031 Exchange (or 1031 Like Kind Exchange) can speed you
on your way. The 1031 Exchange is real property transaction
that involves “property held for productive use in a trade
or business or for investment (except inventory and stocks and
bonds) for property of the same type.” Unless you opt
to reside there, the exchange is nontaxable in the current year!
This is a tremendous benefit to you as your investment property
increases in value, and in a couple years you exchange it for
another (again with no tax liability) and look to the future.
You just need to make sure that you exchange business or investment
property solely for business or investment property of a like
kind. Then no gain or loss is recognized under IRS section 1031.
You may
hear this kind of real of transaction called Starker Exchanges,
Deferred Exchanges, Land Swaps and Trades as well as 1031s.
Here we are just talking about real property, even though these
IRS provisions are also used in many trades or businesses to
trade fleets of equipment such as airliners, trucks, busses,
and so forth.
Example of 1031 Exchange: Farmland out by pastoral
Mars Hill, North Carolina would be Like Kind with an apartment
complex or duplex located in Asheville. Farmland for residential
property that is rented, but that is and not lived in by the
investor, is also Like Kind. Keep in mind that the regulations
concerning section 1031 give specific examples of what is or
is not Like Kind, so it is wise to seek the counsel of your
attorney and CPA while you and I are out locating the replacement
properties.
Wise
Choice:
Since regulations concerning 1031 Exchanges give specific examples
of what is or is NOT like-kind, it is wise to seek the counsel
of your attorney, CPA, and/or a Qualified Intermediary while
you and I are out locating the replacement properties.
Scenario
One:
Here a Like Kind exchange is
the simple swap wherein you trade 130 acres that you own in North
Florida for a purchase of 130 acres of fantastic beauty we currently
have listed here in Western North Carolina. Of course, in reality,
it is quite unusual for a seller and the buyer to have exactly
the same properties, so that is where the tax deferred exchange
comes I handy. In this case, I advise my clients to find a Qualified
Intermediary. Let me explain. Rather than simply selling your
investment property and yourself organizing the purchase of the
replacement property you can select an intermediary. If you were
to control the funds from the sale and the constructive receipt,
you would also trigger capital gain tax.
That tax could be 20% of the
gain recognized by the sale due to appreciation of the property
on my original cost (basis). Higher tax rates could be triggered
by depreciation. So, in order to avoid this capital gain tax when
you you’re your sweet horse farm in Mars Hill, North Carolina
and purchase another horse farm in Florida, you can utilize a
qualified intermediary who will help facilitate the exchange and
avoid the constructive receipt of the proceeds from the North
Carolina farm.
Folks with whom I have worked tell me that they prefer the Deferred
Exchange. A deferred exchange occurs when the property received
in the exchange is not received at the same time as the transfer
of the property given up. For a deferred exchange to qualify as
Like Kind, you must comply with the 45-day written notice and
receipt requirements. This gives my clients (and me) a little
more time to find just the “right” investment property.
Here is where a QUALIFIED INTERMEDIARY comes in handy.
A qualified intermediary is a
person or entity that under the regulations enters into a written
exchange agreement to help facilitate an exchange. It is important
to remember who cannot be a qualified intermediary as there are
disqualified parties under the regulations. These parties include
your family members, your employees, your real estate broker,
or your investment banker. Not to worry, I can refer you to a
qualified intermediary if you choose to use one.
Scenario
Two:
Let’s say that you and
I have found just what you are seeking and that you have signed
the contract for the sale of our fabulous little horse farm in
Madison County (relinquished property). You then assign that contract
to the qualified intermediary you have chosen from the referrals
I gave you, and you close on that property on August 10. Then
you set in motion two (2) clocks! You must keep these two clocks
in mind, they run constantly through weekends and holidays.
The first clock gives you a short
forty-five (45) days from your August 10 closing to let go of
your "relinquished property" and find a "replacement
property." We need to pay close attention, so be sure to
let me know well in advance so that I (or the Broker you choose)
can be available for you during this crucial time.
Now about that second clock:
The second clock begins to run on August 10 and requires you to
close on your replacement property within 180 days, or when my
tax return is due for the year that my relinquished property was
transferred. That may seem like a lot of time, but you know how
time flies, so be prepared.
I enjoy the Hunt for the Replacement
Property. The hills and mountains and “hollers” here
in the Asheville area are full of special treasures. It is a real
thrill to find them. Once we do find your replacement property,
remember, you will have to deliver to your qualified intermediary
a clear description of that property. I can help with that. We
can make sure that there can be no way that the property can be
confused with another property. And we can even identify up to
three (3) properties of any value, or more than three (3) properties,
so long as the total fair market value does not exceed 200% of
the fair market value of what you are relinquishing.
A general rule you may choose
to consider is that the replacement property should be equal or
greater in value, debt, and equity, and if your replacement property
is less than you may well have a tax liability on the difference.
So
that's an overview --just the basics involved in Like Kind exchanges.
REMEMBER: It is important to seek professional guidance as early
in the transaction as is possible.
ASK
janeAnne about 1031 Exchanges
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