Why Is The 1031 Tax Deferred Exchange Important To A Real Estate Property Investor?
    To an investor in real estate it is important to preserve wealth and assets. In the frequently changing world of taxation, the investor is fortunate to have IRC Section 1031. This tax code allows the investor to sell one or more investment properties and to buy one or more investment properties and to defer taxes on the gain. This means that a 1031 Exchange is a rollover of equity of "like" properties, rather than an avoidance of tax. Thus the investor continues to build wealth through real estate investment, and maintains the hard earned equity.

How To Go About a 1031 Exchange and Guidelines Regarding The 1031 Exchange:
 

• A "like" property means when an investment property is sold another investment property needs to be purchased, but it is not limited to the same, as example; a rental duplex can be sold to buy a commercial building, or investment vacant land can be sold to buy an apartment building.
   

• Taxpayer finds a buyer and sells the property through a Qualified Intermediary.
   

• Taxpayer buys a replacement property through the Qualified Intermediary.
   

• The exchange period begins on the day the relinquished property is closed and ends in 180 days from the close of sale. The replacement property is to be identified within 45 days of the close of escrow of the relinquished property.
   

• The taxpayer's agent, broker, attorney, accountant or family member is excluded as a Qualified Intermediary.

    *Tax Rates Vary*: Always consult with a Tax, Attorney, or Tax Advisor. This is a simplified example and other losses/expenses may affect the gain!

With A Properly Executed 1031 Exchange Tax will be Deferred and the investor/owner will have $44,600 more to use towards the purchase of another investment property. The concept of a tax-deferred exchange is easy to understand. However, there are many details involved in an exchange that need to be discussed with your CPA, Attorney, or Tax Advisor before considering a 1031 tax-deferred exchange.

Identification Period: Begins on the date the taxpayer transfers (closes) the sale of relinquished Property and ends at midnight on the 45th day thereafter.
Exchanger Period: Begins on the date the taxpayer transfers (closes) the sale of the Relinquished Property and ends on the earlier of midnight on the 180th day thereafter Or midnight on the due date (including extensions) for the taxpayer's income tax return for the taxable year in which the transfer (sale) of the Relinquished Property occurs.

Additional Rules in Calculating Exchange Periods:
 

• If several Relinquished Properties are to go "into one Exchange", the Identification Period and the Exchange Period are determined by the closing date of the FIRST Relinquished Property.
   

• The Identification Period and Exchange Period are NOT extended to the next succeeding date if the last day falls on a Saturday, Sunday, or legal Holiday.
   

• Property is treated as closed when "legal title" is transferred. "Closing" in some States is not necessarily "recording of the deed".

Rules To Identify Replacement Property:
 

• The general rule for Replacement Property is the sale price is equal to or greater than relinquished property.
   

• The IRS Identification Rules are:
   

  • Three Property Rule: The Exchanger may identify three (3) properties of any value.
     

  • 200% Rule: The exchanger may identify any number of properties if the total fair market value of what is identified does not exceed 200% of the sale price of the relinquished property.
     

  • 95% Rule: If the Exchanger identifies more properties than are permitted under the two rules above, the Exchanger must acquire 95% of what was identified.

How Is The Identification Made?
 

• The Identification must be made to a party to the exchange (i.e., the Qualified Intermediary)
   

• Identification must be in writing and signed by the Exchanger.
   

• The Identification must include street address or legal description.
   

• It must be delivered within 45 days of the close of the Relinquished Property.

How does the Taxpayer Defer all Taxes?
 

• The Taxpayer (i.e. exchanger) must re-invest all cash into the Replacement Property and the debt on the Replacement Property must be greater than the debt on the Relinquished Property.

The Best Way To Establish The Taxpayer's Intent To Affect A 1031 Exchange:
 

• The intent language should be in the Real Estate Contract and Escrow Instructions/Purchase Contract. However a sale can be converted into an Exchange by the creation of an amendment to the Escrow Instructions/Purchase Contract.

    Provided upon request is a complimentary no obligation market evaluation giving you the current value of your investment property. Whether or not you are considering selling, our comprehensive market update and property evaluation report is invaluable and will update your records.

    The information on this page is brought to you courtesy of the California Department of Real Estate.

    Section 121 of the Internal Revebue Code allows single taxpayers who sell a home they have owened and occupied for two of the past years to exempt $250,000 of capital gain. For taxpayers who are married and file jointly, they may exempt $500,000 of gain.

    Section 1031 allows certain investors of real estate to defer capital gains taxes by exchanging into like kind real eastate.

    Recently, astute investors have been combining the benefits of Section 121 and 1031 by exchanging appreciated property into a residence that is rented for a period of time and later converted into a principal residence. After two years of living in the appreciated property, the taxpayer sells the property and receives the beneficial exemption of Section 121 rather than the deferral of Section 1031.

    HR 4520 amends Section 121 to require a 5 year hold period before Section 121 can be used to exempt tax from the sale of a property that was originally acquired as a replacement property as part of a 1031 Exchange. In other words, properties acquired via 1031 Exchange are exempt from Section 121 treatment for 5 years after acquisition.

    HR 4520 takes effect immediately for any property sold on or after October 22nd, 2004

Example:

    In July 2001, Mr. Jones, a single man, exchanged a highly appreciated apartment complex in Texas for a condo in Hawaii. Mr. Jones rented the Hawaii condo for one year and then in 2002 moved into the property, using it as his principal residence. Now that two years have passed since moving into the condo, Mr. Jones would like to sell the condo and use Section 121 to exempt his capital gain up to $250,000. Closing is set for early November, 2004. Due to the new tax law, Mr. Jones willbe unable to use the Section 121 exemption until July 2006, five years after acquiring the property as part of an exchange.

    For more information on Section 1031 and 121, please contact your local tax advisor.

    This information has been provided as a service and the Taxpayer/Exchanger is strongly advised to seek counsel from their own independent tax advisors, tax attorneys, and/or CPA, as to their own specific situation regarding the tax consequences and tax implications due to changing tax laws. Some of my information may now be a bit different because of the constantly changing government laws.