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Thinking of trading up on an investment resort property? If so, look
into 1031 Tax Exchanges (based on IRS Code Section 1031), which allow
taxpayers to defer taxes on capital gains resulting from the sale of
investment real estate, often a sizable sum since combined Federal
and State taxes can run as high as 38 percent.
With an exchange, owners are able to preserve equity, while still
selling the property. The underlying concept is that an exchange of
like-kind property for like-kind property does not generate funds,
which can be taxed since the profits go directly into the new or replacement
property. To accomplish this, sellers hire a Qualified 1031 Intermediary
(QI) to document the sale as an exchange and to receive the funds from
the sale. The QI then delivers the funds directly to the closing agent
for the replacement property who deeds the property to the taxpayer.
Central to a 1031 Exchange is the interpretation of like-kind property.
While the common assumption is that like-kind implies land for land
or a condominium for a condominium swap, the interpretation of like
kind is actually less literal. Rather, it defines like kind as meaning
that both the replacement and the original property must be used as
an investment. So land, condominiums, single-family homes and motels
can all be exchanged for one another as long as they are used in the
exchanger's business or held as an investment. The amount of debt held
on the replacement property must be the same as the amount of debt
on the original.
1031 Exchanges are complex mechanisms and like all IRS requirements
very specific. For example, exchangers have 45 days from closing to
identify properties they intend to purchase and 180 days to complete
the purchase. Purchase and Sale agreements must include verbiage indicating
the intent to affect a 1031 Exchange.
The 45-day time frame used to be onerous for sellers.
Now, they can opt for a Reverse Exchange, in which an additional
third party called "the
exchange accommodation title holder" (EAT) acquires title to the
replacement property until the original property sells. Reverse Exchanges
shift the 45- and 180-day time frame to the selling side of the transaction.
With an Improvement Exchange, which also uses an EAT to hold the replacement
property, sellers can build investment properties from the ground up
or improve existing properties. The improvements have to be built and
paid for during the 180-day period.
If you are interested in a 1031 Exchange, the first step is to consult
your tax advisors as well as an attorney or CPA who is knowledgeable
with 1031 Exchanges. Make sure that your real estate professional knows
you plan to conduct an exchange and be sure that he or she is familiar
not only with the process but also with the specific documentation
and time frame mandated by the IRS.
This article is intended to inform readers, but does not constitute
any financial or legal advice.
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