Cash Flows Occurring In Different Periods Should Not Be Compared Overview of 1031 Tax Deferred Exchange

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Overview of 1031 Tax Deferred Exchange

1031 Deferred tax replacement

A 1031 Tax-Deferred Exchange is a transaction that allows property owners to preserve the full value of their real estate investment. A 1031 exchange allows owners who choose to dispose of their investment properties to do so and avoid paying capital gains taxes by allowing them to reinvest their sale proceeds for “like-kind” properties.

REVIEW

The general rules governing a 1031 Exchange are fairly simple. Any type of asset (real or personal) can be exchanged provided that the transferred asset was previously held for investment purposes. In most cases, a personal residence will not qualify as a tax-deferred exchange.

  1. AS KIND The replacement property must be “similar” to the property being relinquished. “Like kind” does not mean exactly the same. Most any property is considered “eligible” in relation to another property, such as exchanging a single-family rental home for an apartment, warehouse or office building.
  2. VALUE OF THE REAL ESTATE As a general rule, the assets you acquire must have both a value and equity equal to or greater than the assets you are giving up.
  3. IDENTIFICATION PERIOD – Assets to be acquired must be identified within 45 days of the closing of the transferred assets. Asset identification rules include:
  4. Three (3) PROPERTY RULES: Up to three (3) properties can be identified, regardless of their value,
  5. OR THE 200 PERCENT RULE: Any number of properties may be identified, as long as their combined fair market value is not more than twice the property transferred
  6. OR THE 95 PERCENT RULE: Any number of properties can be identified, regardless of their combined fair market value, as long as you acquire 95% of that total value.
  7. REPLACEMENT DEADLINE – The acquisition of a new property must be completed within 180 days from the transfer of the assigned property or by the date of filing the tax return for the year in which the first property was transferred, whichever comes first. These time limits must be strictly after which the Tax Administration will allow a replacement. tax administration not grant extension.
  8. STEPS INVOLVED IN A SUCCESSFUL EXCHANGE
  9. Purchase contract. A contract for the purchase and sale of the transferred real estate is concluded between the Buyer and the Seller. The purchase agreement should contain a “cooperation clause” in which the Buyer agrees to cooperate with the Seller in structuring and completing the 1031 exchange. The seller (or buyer) will assign their interest in the contract to an Intermediary or Qualified Intermediary (FAC or QI).
  10. Exchange open. The exchange is established with the FAC or QI usually after the escrow is opened to close the sale. Next, the necessary documentation that will affect the exchange should be prepared. The exchange agreement (between the taxpayer and the FAC or QI) defines the exchange transaction and sets out the obligations of both the taxpayer and the FAC or QI. A transfer of the contract of sale of the property waived by the FAC or QI is being prepared, whereby the seller’s rights are assigned to the FAC or QI.
  11. Closing of assigned property. The ceded property is closed when all conditions of sale are met and the property is handed over to the Buyer. While the transfer will be directly from the Seller to the Buyer, it will constitute a transfer from the Seller to the FAC or QI in exchange for other assets to be received at a later date. The sale proceeds are delivered directly to the FAC or QI for the replacement property. At no time should the seller be in actual or constructive receipt of cash.
  12. Identification of replacement assets. The time period for identifying the property (or properties) to be purchased as a replacement property starts from the closing of the transferred property. Forty-five (45) days from the date of transfer are allowed for identification of acquired property.
  13. Purchase contract for a replacement property. After identification of a suitable “similar type” replacement property and a decision on which property to acquire, a purchase agreement will be entered into with the Seller. The property must be one or more properties identified by the end of the 45-day identification period.
  14. Replacement of documentation for the acquisition of real estate. After that, the transfer of the purchase contract for the replacement property and the Approval and guarantee to be executed by the Buyer and the Seller should be prepared. Instructions should also be prepared for the settlement agent recording the necessary items to complete the exchange.
  15. Closing on the replacement property. When the closing conditions are met, the FAC or QI should deliver the funds they held to the settlement agent to acquire the replacement assets. The seller will transfer the replacement property directly to the buyer. The closing on the replacement property must occur within 180 days of the transfer of the relinquished property (or by the tax return due date, if earlier) for the transaction to qualify for Section 1031 treatment.

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