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What is a 1031 Exchange?
A 1031 exchange is a transaction in which a taxpayer is allowed to sell one property
and buy another without currently recognizing capital gains, but instead deferring
any tax consequence that may have been incurred. This can be done through a simultaneous
or delayed 1031 exchange. The transaction is covered by Section 1031 of the IRS
Code. The purpose of this strategy is to defer capital gains and recapture taxes
that would arise from the sale of real estate held for investment purposes.
How does a 1031 exchange work?
1. First the seller must identify his intent to do a 1031 exchange prior
to the closing on the relinquished property. At the closing of the first property
the seller includes the exchange language in the contract. This is extremely important
because if you have already sold the property and received any monies you will not
qualify to do a 1031 exchange.
2. At the closing, sales proceeds must go to a Qualified Intermediary (QI)
and are held in a separate account for the benefit of the seller. The qualified
intermediary should have a third party relationship to the seller. For example,
using
your brother-in-law as a QI would not be recommended. Many banks and financial firms
act as Qualified Intermediaries and are recommended. Should you need a referral
to a QI please contact your investment representative or call us at 404-479-8334.
3. At this point the seller has 45 days to identify properties for the potential
1031 exchange. This involves written notification to your QI listing the properties’
addresses and/or legal descriptions of the potential replacement properties. You
may identify up to three different property addresses by simply giving the addresses
to your QI. Should you wish to use more than three properties, please contact your
QI for details of what they will require.
4. The seller has up to 180 days from the closing to actually complete the
purchase of the identified property or properties.
5. Purchase a replacement property that is of the same or greater value as
the property that has been sold.
6. You must reinvest all of the proceeds from the exchange property to qualify
for full deferral of gains. If you choose to do a partial exchange you may be subject
to some tax burden.
7. You must also have the same or greater amount of debt on the new property
as the relinquished property. The seller can also offset the amount of debt obtained
on the replacement property by putting in additional capital in an amount that would
be the equivalent to that of the debt.
8. The seller must sell property that is held for investment purposes and
replace it with property that is to be held for investment purposes.
This is a basic description of how a 1031 exchange may work. You should always consult
with your tax advisor before deciding whether such an exchange is appropriate for
your personal situation.
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