Embracing 1031 5 simple concepts to hold on to. Click to advance.
5 Simple Concepts A 1031 tax deferred exchange is both a complex technique and a simple set of concepts. The complexities arise in keeping an intricate set of rules set forth in the section of the IRS tax code for which 1031 is named and the regulations that further explain those rules. Focusing on 5 simple concepts, to begin with, will greatly benefit your overall understanding of the reasons behind the intricate rules and regulations of 1031 Exchange. Understanding these concepts will also help you navigate and comply with them.
First Concept 1031 exchange is based on the idea of "relinquishing" a property and "replacing" that property so that you are in the same financial position, with the same equity and the same amount of debt. In this way, there is no gain on which to be taxed. Based on the continuity of ownership interest in real property, the IRS will look at that sequence of transactions as if they never occurred. That is, if a taxpayer sells or "relinquishes" a property and receives replacement property of equal or greater value, following all required steps, because he or she continued to own real estate the whole time and has an equal amount of debt with no realized gain, there has been no taxable event.
Concept Two. Avoid constructive receipt of the proceeds of the relinquished property. The qualified intermediary must be in place prior to the closing of the relinquished property. When the qualified intermediary is named as the seller on the closing statement and the proceeds sent to them for safekeeping, and then forwarded as buyer to the replacement property closing, the link established between the properties helps to support the equal financial position you maintained throughout the transactions.
Concept Three As we have established - To keep from paying 24% or more in taxes, the sale of the first investment property must be linked through specific documentation to the purchase of replacement property. In acquiring replacement property, the investor must comply with the basic premise that this tax code section applies to property held for investment or for use in a trade or business. Typically, the phrase "like kind" is used when describing replacement properties. Any kind of real estate would be considered like kind as long as it was held for investment.
Time requirements - The IRS provides two very specific time requirements for completing a 1031 exchange. From the day of the closing of the relinquished property, the day ownership is transferred to your buyer, (Day 0 of your exchange) you have a total of 180 days to acquire replacement property. Fourth Concept. The second and tougher rule to follow is the Identification Rule that requires investors to choose one or more replacement properties. These replacement properties must be listed and identified as replacement properties and sent in writing by the 45th day following the close of the first property. The ID letter is held by the "qualified intermediary" to comply with IRS requirements.
Fifth Concept. Equal or greater value - The last concept for a successful totally tax deferred exchange is acquiring property with a value equal or greater to the value of the property being sold. There are two components to this rule. First, all of the equity or cash from the first property must be spent on acquiring the replacement property or properties. Second, the total value of replacement property must equal or exceed the value of the relinquished property. If there was debt on the first property, the taxpayer will get a mortgage on the replacement property in an amount equal to or greater than the original debt.
To review: (1) saving federal and possibly state capital gains taxes on the sale of investment property by (2) maintaining distance from the funds and (3) acquiring replacement property of a like kind within (4) a time period of 180 days after properly identifying replacement property within 45 days and (5) spending the equity forward on property of equal or greater value.