IRC Section 1031 provides that no gain or loss shall be recognized on the exchange of investment property that is held for productive use in a trade or business, or for investment. A tax-deferred exchange is a method by which a property owner trades one or more relinquished investment properties for one or more replacement investment properties of like-kind. Such an exchange allows the issuer to defer the payment of federal income taxes and some state taxes on the transaction.
The theory behind IRC section 1031 is to allow the property owners to reinvest the sale proceeds into another investment property, foregoing any economic gains that may have been realized from the sale. An advisor can help you explore your 1031 exchange options.
The Exchange Agreement usually provides for:
- An assignment of the seller's Contract to Buy and Sell Real Estate to the Intermediary.
- A closing where the Intermediary receives the proceeds due the seller at closing. Direct deeding is used. An Exchange Agreement should comply with the requirements of the Code and Regulations wherein the taxpayer can have no rights to the funds being held by the Intermediary until the exchange is completed or the Exchange Agreements terminates. The taxpayer "cannot touch" the funds.
- An interval of time where the seller proceeds to locate suitable replacement property and enter into a contract to purchase the property. The interval of time is subject to the 45-Day and 180- Day rules.
- An assignment of the contract to purchase replacement
- A closing where the Intermediary uses the exchange funds in his possession and direct deeding to acquire the replacement property for the seller.
REASONS TO EXCHANGE
- The top reason to conduct the sale of investment property as a Section 1031 Exchange is the dramatic opportunity for wealth building. Whether the property is owned by an individual, trust, LLC, S-corp or C- corp, utilizing untaxed dollars to acquire more significant investment property and generate greater cash flow from investment property is the number one benefit of an exchange.
- The goal in an exchange is to defer capital gains tax on the federal and state level, and avoid recapture of previously taken depreciation. On a combined basis, the tax implications can range from 15% to 30%.
- Convert no or low income producing property for higher income/appreciation property. Sell that piece of land that is not producing any cash flow and use the proceeds to acquire income producing property.
- Diversify/consolidate the types of property held. Since the value is what is being exchanged, 1031 allows the investment dollars to be broken up into several new investments or conversely, taking several investment properties and consolidating them into one significant property.
- Relocate investment property from one geographic market to another. Planning to relocate and want to take your investment property with you? Go ahead; it can all be done tax deferred.
- Solve problem of joint ownership. Your investment partner has ideas of his/her own. Exchange out of the ownership and go your separate ways without triggering tax.
- Reinvest in passive real estate, oil & gas and UP-REIT’s.
- Acquire investment property that you later convert to your primary residence. Changing the use of an investment property that has been held by you and used as investment property for at least two years and later converted to your residence is not a tax triggering event.
- Buy exactly what you want with a Build-to-Suit Exchange. Use the proceeds of the sale of existing investment property to acquire land and construct a new facility that is exactly what you want.
- Planning opportunity for all exchanges that begin after July 5th. Section 1.1031 (k)-1(j) allows the taxpayer the option to declare which year any boot is taxed, the year of sale or the year of receipt.
Beacon Exchange Co.
241 A Street, Suite 310
Boston, MA 02210