Example:  John Q. Investor lives and works in Atlanta, Georgia.  He owns three rental houses (or vacant lots or office buildings) each worth $100,000.  John bought the houses for $50,000 each and has been depreciating them for ten years.  If John sells them he will owe approximately $9,500 in capital gains and another $4,545 in depreciation for a total of $14,045 on each house.  What a tax burden!  John decides he cannot sell them because his taxes will take too large a portion of his profit. 

 

John and his family frequently rent a condo down in Destin every year and each time he sits on the beach, he kicks himself for not having invested down here "when he could afford something".  John knows that the "Residence Roll-over" and the "one time over 55" exclusions are no longer in effect but he has not heard of a 1031 tax deferred exchange.  I speak to John on one of his family vacations and give him an overview of how a 1031 could solve his investing dilemma. 

 

John will be able to sell the three houses and exchange them for an investment condo without paying any taxes.  After 12 months or so, John and his wife could even convert the rental condo into his principal residence and in another two years, sell it and pay no taxes on any gain of $500,000 or less.  If John wishes to leave the condo to his children some day, the children will have a basis of "market value as of the date of death."  John grins and asks, "What's the catch?".  The catch is that certain procedures must be followed to the letter and to the minute.  The IRS created these rules and only asks that you follow them.

 

 

(Please note that I will be happy to send you detailed info on request via email.)

 

1.  Qualifying property

 

An Exchange of income, investment or business property for another like-kind replacement property allows a taxpayer to defer taxes which would be owed on an outright sale of his/her property.  "Like-kind" replacement property simply means any improved or unimproved real estate held for income, investment or business use, i.e. an office building or rental house may be exchanged for a condo as long as both are held for investment, and not as a personal residence or second home.  One property can be exchanged for two or more and vice versa.

 

2.  Accommodation Language

 

"Accommodation language" is highly recommended in your real estate sales contract to accommodate the exchange.  Simply insert this paragraph into your contract, "It is Seller's intent to perform an IRC Section 1031 Tax Deferred Exchange by trading the above described property.   Buyer agrees to execute an Assignment Agreement at the request of Seller at no additional cost or liability to the Buyer."

 

3.  Time Lines

 

On or before the 45th day following the sale of a "relinquished property", an exchangor must submit a list to a qualified intermediary identifying three properties which may become the "replacement" property.  One of these three properties MUST be the property you ultimately acquire, so it is imperative to begin "shopping" early.

 

An exchangor must acquire a replacement property within 180 days following the sale of the relinquished property OR the due date of the Seller's tax return, whichever occurs first.

 

4.  Qualified Intermediary

A qualified intermediary enters into an Exchange Contract with the taxpayer/exchangor and subsequently enters into a sales contract via an Assignment Agreement.  The intermediary controls all exchange proceeds.  If the taxpayer/exchangor receives any exchange proceeds, the exchange may fail and the taxpayer will be required to pay taxes.  The intermediary must be a fourth party to the transaction, not related to or serving as any type of agent to the taxpayer.

 

5.  Receipt of "Boot".

To defer capital gain, transactions must be structured to avoid receipt of "boot" which is defined as unlike property received in an exchange.  Examples of boot include personal property, cash, notes and debt (mortgage) relief.  An exchangor is required to trade for replacement property which is equal or greater in value with respect to equity and mortgage.  Cash boot received cannot be offset by a larger mortgage, but can be offset by increasing the amount of cash brought to the table.

 

There are many more intricacies involved, however to go into them here, without knowing your specifics would take up too much of your time.  In a matter of minutes a qualified expert can shed light on your particular situation at no cost to you.  Give me a call or email and let me know what area of the country you live in and I can give you an 800 # .

 

In my opinion, there is no greater tax strategy than the 1031 as it relates to real estate transfers.  I invite you to let me help put this strategy to work for you!