There's no shortage of television shows addressing real estate these days. Many of
these programs emphasize "flipping" properties when an adequate gain has been
reached. But, if you're ready to move one of your investments, you might prefer to
exchange it rather than flip it.
Reviewing the concept
Section 1031 of the Internal Revenue Code allows you to defer gains on real or
personal property used in a business or held for investment if, instead of selling
it, you exchange it solely for property of a "like kind." In fact, these arrangements
are often referred to as "like-kind exchanges." Thus, the tax benefit of an exchange
is that you defer tax and, thereby, have use of the tax savings until you sell the
Personal property must be of the same asset or product class. But virtually any type
of real estate will qualify as long as it's business or investment property. So if
you wish to exchange your personal residence (including a vacation home), you'll have
to first convert it into an investment property.
Executing the deal
Although an exchange may sound quick and easy, it's relatively rare for two investors
to simply swap properties. You'll likely have to execute a "deferred" exchange, in
which you engage a qualified intermediary (QI) for assistance.
When you sell your property (the relinquished property), the net proceeds go directly
to the QI, who then uses them to buy replacement property. To qualify for
tax-deferred exchange treatment, you generally must identify replacement property
within 45 days after you transfer the relinquished property and complete the purchase
within 180 days after the initial transfer.
An alternate approach is a "reverse" exchange. Here, an exchange accommodation
titleholder (EAT) acquires title to the replacement property before you sell the
relinquished property. You can defer capital gains by identifying one or more
properties to exchange within 45 days after the EAT receives the replacement property
and, typically, completing the transaction within 180 days.
The rules for like-kind exchanges are complex, so these arrangements present many
risks. If, say, you exchange the wrong kind of property or acquire cash or other
non-like-kind property in a deal, you may still end up incurring a sizable tax hit.
Be sure to call us when exploring a Sec. 1031 exchange and particularly before
executing any documents.
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whatsoever in connection with its use. The information contained in this newsletter
was not intended or written to be used and cannot be used for the purpose of (1)
avoiding tax-related penalties prescribed by the Internal Revenue Code or (2)
promoting or marketing any tax-related matter addressed herein. © 2016