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1031 Exchanges for
Real Estate Investors
You can sell your property today, reinvest the profits
within the next six months and delay the taxes on the gain.
We have the 1031 investment expertise to help you avoid
taxes while you build real estate wealth.
A 1031 exchange is like getting an interest free loan from
the IRS
The 1031 Delayed Exchange
The delayed exchange, also called a Starker exchange, is a
very special investment technique which can only be used in
real estate transactions. You are allowed to sell your
property today and to reinvest the profits as long as six
months later without having to pay the taxes due on the
sale. Taxes are deferred to a future date that you choose.
After you sell your property, you have 45 days to identify a
new property and 180 days to purchase it.
A simple example of how it works and why you should do an
exchange
Let's say you bought an investment property and sold it with
a capital gain of $200,000. After taxes and depreciation
recapture you owed $50,000 in taxes. You now have $150,000
to invest in your next property. If we use a 25% down
payment, you can buy a new property worth $600,000 and
hopefully continue to build your fortune.
If you used a 1031 exchange and delayed the taxes on the
property, you would have $200,000 to reinvest. Now you could
purchase a new investment of $800,00.
The IRS is permitting you to defer your taxes. They feel
that you will continue to make more money and some day you
will pay them on all of the gains. It is like an interest
free loan from Uncle Sam.
Delayed exchanges use a Qualified Intermediary to assist in
the trade. The Qualified Intermediary is a principal in the
exchange who accepts the exchangor's property, sells it and
then, at a later date, purchases the trade property and
transfers it to the exchangor. The exchangor gives his
property to the Qualified Intermediary and receives a
property in trade. The transaction is a perfect 1031
exchange which occurs in two stages rather than one.
To have a proper delayed exchange, it is necessary for the
Qualified Intermediary to be a bona-fide principal in the
transaction. The cash which the Qualified Intermediary
receives for the sale of the exchangor's real estate must
become the property of the Qualified Intermediary. The
exchangor should have absolutely no control of the proceeds
from the sale. The transaction should include an exchange
agreement in which the disposition of the exchangor's
property and the acquisition of the trade property are
interdependent. That is, the trade out of the exchangor's
property cannot take place without a requirement that the
exchangor receives a property in return.
Translation - You sell your property through someone else
who is actually accepting the money. You have 45 days to
identify some properties that you want to purchase with the
proceeds of the sale and 180 days to purchase them. You do
not have to buy all of the properties that you identify as
prospects. When you sell your property, the Qualified
Internediary is holding the funds. When you purchase the new
property, which must be within 180 days, the Intermediary is
making the purchase.
Every exchange provides opportunities for wealth-building,
but also provides the opportunities for penalties in the
event the exchange is performed incorrectly. The delayed
exchange is entirely legal, defensible, and has been used
thousands of times over the last ten years. However, it is
imperative that the exchangor and his agent obtain
qualified, correct advice on the exchange before committing
to the transaction. In other words, make sure the Qualified
Intermediary knows what they hell they are doing. We have
some good people and I will recommend a few.
REVERSE EXCHANGE
This is simply the reverse of a delayed exchange. This
occurs when an investor identifies and purchases replacement
property prior to the sale of property he relinquishes.
Federal guidelines for a reverse exchange were issued
September 15, 2000 so we have safe harbor rules to follow.
AN IMPROVEMENT EXCHANGE
This allows the investor to construct a new replacement
property within certain guidelines including time
constraints.
WHO SHOULD CONSIDER A 1031 EXCHANGE?
Anyone who is thinking about selling a business use or
investment property should consider affecting 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.
Essentially, 1031 Exchanges should be thought of as an
interest free loan from the IRS; one in which the principal
may be increased through subsequent exchanges and may never
require repayment, if you plan properly.
MISCONCEPTIONS ABOUT EXCHANGING
1. Many still believe that you must Swap properties.
Although this was required in the original code, this is
rarely done in present times. 1031 Exchanges now enable one
to sell their property to someone totally unrelated to the
person from whom they are purchasing their replacement
2. Many believe only investors of large commercial
properties can utilize the benefits of Section 1031. The
great thing about 1031 Exchanges is that it applies to all
investment properties, large and small. It will work the
same way for a corporation selling a large shopping center
as it would for an individual selling a single-family home
used as a rental property in a vacation area.
3. Many believe you must acquire a property of "similar use
or service." While 1031 exchanges are also known as
"like-kind" exchanges, like-kind simply applies to real
property held for business use or investment. Therefore, an
investor may sell raw land and acquire a five-unit apartment
building or sell a warehouse and acquire raw land. He can
sell one property and acquire three or sell four and acquire
one. Virtually any type of real property used for business
use or investment will qualify.
4. Many believe 1031 exchanges are very complicated and not
worth doing. The fact is that when working with a qualified
intermediary who specializes in Section 1031 tax deferred
exchanges, the exchange process is very simple. The
intermediary will keep you aware of your time deadlines and
ensure you do everything in strict compliance with IRS
regulations.
ADVANTAGES OF EXCHANGING
1. The Exchanger will have more buying power because the
federal income taxes are deferred. This will enable him to
leverage himself up greater than he could have had he paid
the tax liability. The additional equity to reinvest will
make him a more solid buyer and help him get easier
financing.
2. Investors can do exchange after exchange to create a
pyramiding effect. This tax liability is forgiven upon the
death of the investor as the heirs get a stepped up basis on
the inherited property.
3. The Exchanger will have greater selling power because he
does not have to inflate the sales price to try to cover
some of the capital gains that would normally be due upon
the sale of an investment property. It will enable him to be
more flexible with the selling price.
4. The Exchanger can acquire a replacement property with
greater income potential. He can sell raw land and acquire
income-producing property. Perhaps, he wants to acquire a
building with additional units or in an easier to rent
location.
5. The Exchanger has the opportunity to consolidate several
hard to manage properties in one easy to manage property or
diversify several small properties into one large property.
It provides an excellent opportunity to relocate or expand a
current business or investment.
6. An exchange can also help an investor acquire a less
management intense property
SLIGHT DISADVANTAGE
The basis of your replacement property will be lowered by
the amount of gain deferred on the sale of your relinquished
property. However, when weighing this against the deferred
gain, the astute investor can clearly see he is still
significantly ahead.
LIMITATIONS ON THE NUMBER OF REPLACEMENT PROPERTIES THAT CAN
BE IDENTIFIED:
1. THREE PROPERTY RULE:
Exchanger may identify up to three properties regardless of
their fair market value. The Exchanger is not obligated to
purchase all three properties but must purchase at least one
of the three identified properties. For example, if selling
a relinquished property for $100,000, three replacement
properties can be identified with a combined fair market of
$750,000.
2. 200% VALUE RULE:
Exchanger may identify more than three properties but their
combined or fair market value cannot exceed double (200%)
the fair market value of the relinquished property. For
example, if a relinquished property was sold for $100,00 and
four or more replacements are identified, their combined
fair market value cannot exceed $200,000 with 200% or double
the sale price of the relinquished property.
Exceptions to the Three Property Rule and the 200% Value
Rule:
1. Any replacement property acquired within the 45-day
Identification Period will be treated as properly
identified, regardless of whether or not it is within the
Three Property Rule or 200% Value Rule.
2. If the Three Property Rule and 200% Value Rule are
violated, the property will still be treated as properly
identified, provided that 95% of the combined fair market
value of the identified replacement property has been
acquired. For example, assume a $100,000 property was sold
and five properties with a combined fair market value of
$800,000 are identified. This will be treated as properly
identified provided all five properties are acquired. It is
almost impossible to acquire 95% of the property without
acquiring all 100% of the property.
We have spoken to real estate agents and brokers who do not
know the IRS guidelines for a 1031 exchange and will get you
into deep trouble with severe tax penalties. Make sure you
work with someone who knows what they are doing. (Perhaps,
someone like myself for example.)
We use a Qualified Intermediary for all 1031 exchanges.
However, not every deal qualifies and there are still
certain sections of the IRS rules that are open to
interpretation. Some agents, due to their lack of experience
or just plain indifference, will have you do an unqualified
exchange. What do they care? They are only interested in
selling more property.
The 1031 exchange is a powerful tax planning tool when used
properly. It can save you a fortune in taxes as you build
more and more real estate wealth.
Our expertise in the use of 1031 exchanges is just another
factor that sets us apart from other real estate investment
companies. Call us to discuss how we can help you begin
investing in conservative but highly profitable real estate
deals.
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