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No Gain, No Pain!
Everyone is talking about 1031 Exchanges these
days. As rightly they should! The Section 1031 Tax-deferred Exchange is
the most powerful investment tool available to the U.S. Taxpayer
for Wealth Building and Estate Planning! As our Resort Real Estate
market has matured and gained momentum over the last five years, many
owners have found themselves faced with considerable, even dramatic
capital gains exposure. With Federal tax at 28% and State at 5% you can
easily be paying out a Third of every Dollar that’s in your real estate!
The Section 1031 Exchange gives you the ability to
move equity (anywhere in the US) into a more desirable property without
triggering (recognizing and paying) capital gains until a future date.
This deferral of Capital Gains (at whatever rate they are) allows
you to convert what would have been tax dollars INTO investment
dollars, and results in what is virtually an interest-free loan
from Uncle Sam! This unequalled Estate Building tool allows you to
Increase your Buying Power, and to pick the year for you to realize your
capital gains.
The 1031 Exchange has become a hugely important
strategy for resort real Estate investors and owners. Fully one in
three of our real estate transactions in recent years has involved a
1031 Tax–deferred Exchange on either the buyer or seller’s side.
Remarkably, most of them have been owners who have traded back into
another property here in the Breckenridge area: into a newer or larger
property, from a condo to a home, from vacant land into a condominium.
Others are selling their depreciated rental property back home and
converting them into holdings here in the Kingdom of Breckenridge.
Whatever the reason, you want to make sure you have a valid exchange when
done!
You can call anything you want an exchange, but if
the IRS determines later that the form and substance of the exchange
weren’t structured correctly, the IRS can disallow the exchange and
them WHAM! You get to realize the capital gains, PLUS penalties, PLUS
interest back to the year when it was due! Section 1031 of the Tax Code
is unique in that it is the Structure, not the Intent that determines a
successful exchange. You should make sure you have the involvement of
a Qualified Intermediary (Exchange Accomodator). Of course you should
consult with your Tax Advisor, accountant or attorney to determine
if an Exchange is right for you, but NOTE that they cannot perform the
exchange for you! (They are Dis-qualified Persons).
MAKE THE TAX LAWS WORK FOR YOU! See why the
1031 Exchange is one of the most powerful wealth building tools in
America.
TEN QUESTIONS YOU NEED TO KNOW
ABOUT 1031 EXCHANGES!
What does an Exchange Accomodator (Qualified
Intermediary) do?
The Qualified Intermediary and the Exchange
Accomodator are the same thing. They act as a “safe harbor”
approved by the IRS to hold the exchange proceeds and to make sure that
the structure of the exchange is properly observed. Note that there are
many persons who are Disqualified by the IRS to act as Accomodator: your
attorney, your accountant, your broker, investment banker, or a relative
cannot perform the Exchange for you.
The Accomodator does more than just hold the money
to avoid “constructive receipt”, they actually create the
mechanism for a trade. In the case of a Reverse or Improvement Exchange,
they provide a safe harbor for the title of the replacement property to be
“parked” until the exchange is completed.
What is the timing of the sale and acquisition of
my new property?
You have up to 45 days after the sale of the
Relinquished Property to choose your Replacement Property. The
Replacement Property MUST be one selected during that period. You have no
more than 180 days to close on the Replacement Property, OR the next due
date, including extensions, of the tax return for the year in which the
exchange occurred, whichever is EARLIER.
For example, any exchange initiated after October
17, you will have LESS than 180 days unless you file the proper extension
with IRS. Christmas and Sundays count!!
What is Identification and when do I do it?
To qualify for a Sec. 1031 tax deferred exchange,
the tax code requires that the Replacement Property be identified during a
strictly observed time period. The Identification period begins when you
transfer the Relinquished Property (the one you parted with), and ends at
midnight of the 45th day. Don’t be caught by the clock--
Christmas and Sundays count!
You can select several (or multiple) properties,
and even change your mind about your choices during the period. However,
you may ONLY acquire a property that was identified during the 45-day
period, not after.
The Exchanger (you) is required to specify the
property (or properties) clearly with legal description, address, unit
number or name:
*In a written document signed by Exchanger
*Hand delivered, faxed or mailed
*Before midnight on the 45th day
*To the person responsible for transferring the
new replacement property to you (generally the Qualified Intermediary), or
any other person involved in the exchange other than you or any
Disqualified Person.
What if somebody else buys my Identified
Property?
So, your 45 days have passed and you properly
identified your three properties; you wrote them down and mailed them off
all timely and everything, and then you come to find out that somebody
else &#%!! has put in a contract, and that one, or more of them are sold.
Ouch! You can only acquire one of the properties identified
during the period. However, Identifying on paper is one thing—it is
best that the Exchanger take decisive steps towards having a contract
on your Replacement Property, so that the ticking clock doesn’t
make your decisions for you.
Can I trade my vacant land for a condo?
If both are held for investment or the production
of income, yes. Or, you can trade a parking lot for an apartment building.
The manner is which the property is held or used will determine if it is
“like-kind” in the eyes of the IRS, and suitable for exchange.
Can I trade my second home?
To qualify for a tax-deferred exchange, the
property must have been held for investment, or the production of income.
Typically your second home will not qualify for this treatment. Have you
rented the property out? How have you treated the property on previous
year’s tax returns? There are specific strategies for converting
the use of a property into one appropriate for exchange (Conversion).
Again this is where you need the assistance of an experienced Exchange
Accomodator to properly position your asset.
What if the one I want is under construction and
not complete?
The Reverse Exchange may be combined with
an Improvement Exchange to allow for construction improvements to
be included in the exchange, which may be supervised or managed by the
Exchanger, however, the 180-day time limit will still apply. The exchange
for the Replacement Property must be completed during the 180 day period.
You need to make sure that your contemplated property will be completed
and ready to close. Count your days carefully!
Can I condo in the Caymans?
Sorry! Properties outside the U.S. or its
possessions are not like-kind and cannot be exchanged. Try St.
Thomas instead!
What is BOOT?
Boot is “non-like-kind” property received
in an exchange (such as cash), and is a taxable event. Boot
is when the IRS says you received “extra money” in the exchange. There are
many ways to trigger this recognized gain besides getting a pile of cash!
Debt Relief (of a mortgage on the Relinquished Property) will be
treated as Boot (or cash received) unless it is offset by new debt on the
Replacement property.
Rule of Thumb for 100% Tax-Deferral:
Trade even or up in value
Trade even or up in equity
Trade even or up in Debt
AND USE ALL THE PROCEEDS
Why can’t I just leave the money in an escrow
account and not touch it?
If you have direct control over the disposition of
the exchange funds during the 180-day period (escrow instructions, for
example, or deciding when to release escrowed funds), the IRS figures that
you received the money in a sale, and then made a subsequent
repurchase. No Exchange! This is called “Constructive
Receipt” and is a fancy way of the IRS saying, you got the money,
and it triggers all of the gain, plus potential penalties and interest.
The proper paper trail with the Exchange Accomodator is essential for
documenting where the money went, and who holds it.
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