1. What is a 1031 exchange?
2. Who should consider a 1031 exchange?
3. What is "INTERNAL REVENUE CODE section 1031"?
4. What is 1031"LIKE KIND" property?
5. What is IRC section 1034 property?
6. Why exchange property instead of just selling it?
7. When is A 1031 tax-deferred exchange applicable?
8. What is the current identification period, and closing time to accomplish a delayed 1031 tax deferred exchange?
9. What happens to the money?
10. what happens when the exchanger obtains a new loan from an institutional lender?
11. When is the best time to notify related parties about the intent to complete a 1031 exchange?
12. Can I close on my replacement property before I have a buyer for my relinquished property?
13. How do I report my 1031 exchange to the IRS?
14. What is a qualified invester?
15. If I already signed my agreement of sale, is it too late to initiate a 1031 exchange?
16. What is needed when the exchanger is a partnership, corporation or trust?
17. What is A QUALIFIED INTERMEDIARY?
18. What is BOOT?

1) What is a 1031 exchange?

Internal Revenue Code section 1031 provides that no gain or loss will be recognized on the exchange of any type of business use or investment property for any other business use or investment property. 1031 Exchanges are not really exchanges in the context of two-party barter. Instead, they are typical sales and purchases that involve the same exact ingredients as any other sale or purchase, deferring the capital gains. The only real difference is the investor is increasing his selling and buying power by electing to defer the immediate effect of taxes under section 1031 regulations. No other aspects of the transaction are affected.

2) Who should consider a 1031 exchange?

Anyone who is thinking about selling a business use or investment property should consider effecting a 1031 Exchange. An Exchange offers the astute investor an opportunity to reinvest the federal capital gains that would normally be handed over to the IRS and put that money to work for himself. You work too hard to simply pay the tax without carefully considering this reinvestment option.

*To defer all of the capital gains, an investor must acquire property equal or greater in value to the property sold, and must reinvest all equity from such property. Receiving cash, or trading down in value, is treated as boot and taxed as capital gain.

3) What is "INTERNAL REVENUE CODE section 1031"?

section 1031 of the Internal Revenue Code relates to the disposition of property that is held for use in productive trade or business or held for investment. If performed properly, code section 1031 provides an exception to the rule requiring recognition of gain upon the sale of property. The current Federal tax rate (maximum) on long term capital gains is 15%, plus any applicable state taxes. Long term capital gains are not taxed as ordinary income. There is also a 25% recapture tax in addition to the 15% capital gains tax on the depreciation taken on the property since purchase.

The most important reason is to be able to defer potentially taxable gain one may realize from a sale of the property. This way one may be able to use All OF THEIR EQUITY to acquire another property, instead of the amount of equity left over after paying applicable Federal and State income taxes on their gain. Additionally, the ability to go from one type of property to another allows an investor to utilize these other concepts: Leverage, Diversification, Cash Flow, Consolidation, Management relief, and possibly Increase their Depreciation.

It is possible, under the current IRS section 1031 rules, to continue to exchange properties, using all of your equity, thus potentially increasing your portfolio Net Worth than were you to sell properties, pay the taxes, and then acquire another property with the remaining equity.

For an exchange to be 100% tax deferred, the Exchanger must acquire replacement property that is of equal or greater value and spend all of the net proceeds from the relinquished property. Many specific requirements must be satisfied in order to complete the exchange properly. Receiving cash or trading down in value is treated as boot and taxed as capital gain.

4) What is 1031"LIKE KIND" property?

This means that business property or property held for investment, may be disposed of to a buyer (sold), set up with a "Qualified Intermediary", put into escrow, which will document the transaction as an exchange, and within the codified time frame, repurchase replacement property of "like kind" thereby completing the exchange. It is not required that exactly the same type of property is acquired. Like kind property that can be exchanged under the current meaning of Code section 1031 includes a wide variety of property THAT IS HELD FOR PRODUCTIVE USE IN A TRADE OR BUSINESS, OR, property THAT IS HELD FOR INVESTMENT. "Like kind" property can include, but is not limited to any of the following, provided it is held for investment: commercial, single family rental property, condos, raw land, apartments, vacations home, second home, duplexes, industrial properties and a Leasehold Interest of 30 years or more.

A persons PRIMARY RESIDENCE does NOT come under the rules of section 1031, and is specifically EXCLUDED, as is property held "primarily for resale" or dealer property.

A common misconception to "like kind" is that the properties being exchanged be of "similar use". This is simply not true. A commercial property can be exchanged for an apartment complex or bare land exchanged for a single- family rental.

5) What is IRC section 1034 property?

IRC section 1034 encompasses a primary residence only. A taxpayer is only allowed one primary residence, therefore, by reason of default, any other real property could be considered possible 1031 property. The only condition is that it meets the guidelines of section 1031.

6) Why exchange property instead of just selling it?

The most important reason is to be able to defer potentially taxable gain one may realize from a sale of the property. This way one may be able to use All OF THEIR EQUITY to acquire another property, instead of the amount of equity left over after paying applicable Federal and State income taxes on their gain. Additionally, the ability to go from one type of property to another allows an investor to utilize these other concepts: Leverage, Diversification, Cash Flow, Consolidation, Management relief, and possibly Increase their Depreciation.

It is possible, under the current IRS section 1031 rules, to continue to exchange properties, using all of your equity, thus potentially increasing your portfolio Net Worth than were you to sell properties, pay the taxes, and then acquire another property with the remaining equity.

*To defer all of the capital gains, an investor must acquire property equal or greater in value to the property sold, and must reinvest all equity from such property. Receiving cash, or trading down in value, is treated as boot and taxed as capital gain.

7) When is A 1031 tax-deferred exchange applicable?

It is applicable when the property in question falls within the "like kind" definition and the principal intends to BUY another property of "like kind" within 180 calendar days following the close of escrow from the SALE, and when the Investor has a recognizable gain.

Remember, under the delayed exchange parameters, there is a maximum of 180 calendar days to purchase replacement property. If the principal is not sure prior to closing the sale property, it is a good idea that the transaction is structured as an exchange rather than a sale. Otherwise, if the escrow is closed without the exchange protocol in place, the principal will have receipt of proceeds and cannot perform an exchange. If the exchange is "set up", the principal has the option of deferring taxes.

8) What is the current identification period, and closing time to accomplish a delayed 1031 tax deferred exchange?

After an exchange has been "set up", by contacting a Qualified Intermediary prior to closing a sale, the Seller, Exchanger, may identify up to three (3) potential properties they MAY intend to acquire, within 45 days of the close of the "sale" escrow.

One can list, or identify, five (5) or more, properties, however these properties cannot have an aggregate value of 200% or more of the sale property. If more than three (3) properties are identified, and the value exceeds 200% of the sale price, then you must close escrow on 95% of the list. Escrow must close, on at least one of the identified properties, within 180 calendar days from the date of the close of the sale escrow. Be sure to check with your legal and/or tax advisor.

9) What happens to the money?

It is imperative that the Exchanger (who is the owner and seller of the property) does NOT receive any money. The Seller's net proceeds are wired to the Intermediary into a separate, interest bearing account. Each exchange has its own account; therefore, you must call the Intermediary BEFORE wiring to obtain the account number.

At the closing of the replacement property, the funds required to close the transaction will be wired from the exchange account held by the Intermediary. In the event there is insufficient funds in the exchange account to close your escrow/ closing, then the Exchanger will have to deposit the additional funds required to close the escrow/closing.

10) what happens when the exchanger obtains a new loan from an institutional lender?

The Intermediary does not need to see or sign any of the lender's documents. This is the Exchanger's loan and only the Exchanger should be signing. Most lenders do not have a problem with the Qualified Intermediary inserted as the Exchanger's Name on Instructions or Settlement Statements. However, if the lender does not want to see an Intermediary's name on your statements or instructions, you can eliminate their name on items sent to the lender.

11) When is the best time to notify related parties about the intent to complete a 1031 exchange?

The IRS requires you to notify the buyer of your relinquished property and the seller of your replacement property of your intent to complete a 1031 Exchange. However, you should wait until all terms of the Agreement of Sale have been agreed upon before making this notification. Ideally, you would like to have the cooperation of your buyer and seller but it is not necessary, as regulations simply require that they be notified in writing.

12) Can I close on my replacement property before I have a buyer for my relinquished property?

Yes. This exchange process is known as a Reverse Exchange. The IRS has adopted regulations specifically for Reverse Exchanges. The Reverse Exchange receives basically the same benefits as the Deferred Exchange and the Revenue Ruling sets up the guidelines needed to structure the Reverse Exchange. To make the exchange work, someone other that yourself (usually your intermediary) must take title to one of the properties until you are ready to convey the relinquished property to a buyer.

13) How do I report my 1031 exchange to the IRS?

Initially, your 1031 Exchange is reported on the IRS form 1099S which should indicate that you are effecting a 1031 Exchange and will receive property as consideration for the sale of your relinquished property. IRS Form 8824 must be completed as part of your annual federal return. In addition to determining your realized gain, recognized gain and your new basis, this form will ask the date you sold your relinquished property, identified and acquired your replacement property. Form 8824 is actually a supporting form for IRS Form 4797. The income received on rental properties must be reported on Schedule D of Form 1040.

14) What is a Qualified Invester?

• a natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase;
• a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
• a trust with assets in excess of $5 million , not formed to acquire the securities offered, whose purchases a sophisticated person makes.

15) If I already signed my agreement of sale, is it too late to initiate a 1031 exchange?

No, as long as you have not settled on the property you are selling, a 1031 Exchange can still be completed. However, once the closing occurs, it is too late to utilize the advantages of section 1031.

16) What is needed when the exchanger is a partnership, corporation or trust?

There is nothing different in how the exchange is handled, but the Intermediary will need to see a copy of the Trust Agreement, the Partnership Agreement, or a Corporate Resolution.

17) What is A QUALIFIED INTERMEDIARY?

The Intermediary is the entity that structures, consults, guides and documents the exchange transaction from beginning to end. An Intermediary will hold the funds and provide technical experience to maintain the integrity of the exchange. They do not replace competent tax or legal advice. Quite the contrary, they are not allowed to give tax or legal advice.

18) What is BOOT?

Boot is defined as any "NON LIKE KIND" property received by the Exchanger in the exchange and it is taxable.
CASH BOOT: Cash Boot consists of any funds received by the Exchanger, either actually or constructively. If an Exchanger does not spend all of the proceeds from the sale of the relinquished property, he/she will have actual receipt of the balance not spent and pay taxes on that amount.

MORTGAGE BOOT OR DEBT RELIEF: Mortgage Boot occurs when the Exchanger does not acquire debt that is equal to or greater than the debt that was paid off, therefore, they were "RELIEVED" of debt. If the Exchanger does not acquire equal or greater debt on the replacement property, they are considered to be "RELIEVED OF DEBT", which is perceived as taking a monetary benefit out of the exchange. Therefore, the debt relief portion is taxable, unless offset by adding equivalent cash to the transaction.

An Exchanger must buy of equal or greater value while spending the NET (after costs) equity. It is absolutely acceptable to take cash out of the exchange and pay taxes on that amount only.