What is a typical Section 1031 Exchange?

To accomplish a 1031 exchange, there must be an exchange of properties. The simplest 1031 exchange involves a contemporaneous swap of one property for another. Often the closings on both properties occur at the same title company on the same day.

Who qualifies for a Section 1031 exchange?

Owners of investment and business property – including individuals, C corporations, S corporations, partnerships (general or limited), limited liability companies, trusts and any other taxpaying entity – can qualify for a Section 1031 deferral.

What are the typical steps I have to take to complete a 1031 Exchange?

The typical steps you need to take are:

  1. Owner and buyer sign sales contract for property with a cooperation clause
  2. Owner and/or their Realtor retains Brazos 1031 Exchange Company before closing.
  3. Owner signs Brazos 1031 Exchange Company’s exchange documents at the title company during closing on the property being sold (“Relinquished Property”).
  4. Sale proceeds are wired to Brazos 1031 Exchange Company’s client trust account.
  5. Owner identifies new investment property (“Replacement Property”) within 45 days of closing.
  6. Brazos 1031 Exchange Company closes on replacement property within 180 days of original sale (unless due date is extended).
  7. Property is directly deeded to Owner and the exchange is complete.
  8. Owner reports the transaction on his tax return in the year in which the Relinquished Property was sold.

 

 

How Does a Reverse 1031 Tax Deferred Exchange Work?

In a typical tax deferred exchange, the taxpayer sells the relinquished property and either contemporaneously or later acquires the replacement property. This process is reversed in what is called a “reverse exchange.” In this permutation of the exchange process, the replacement property is purchased before the relinquished property is sold.  In the typical reverse exchange, the taxpayer identifies the replacement property and obtains the agreement of a third party, called an “exchange accommodation titleholder,” to take title to the replacement property on the taxpayer’s behalf before the taxpayer sells the relinquished property.

A taxpayer may want to use a reverse 1031 exchange for several reasons:  (1) the taxpayer has not yet found a buyer for the property to be relinquished; (2) the taxpayer must close on the replacement property by a certain date to obtain favorable financing or avoid forfeiting a deposit; or (3) improvements need to be made on the replacement property.

The IRS has published procedures that provide what is called a “safe harbor” in a reverse exchange. Compliance with this safe harbor provides assurance to the taxpayer that the characterization of the properties involved in the transaction, and their interim ownership by the titleholder, will be deemed in compliance with IRC Section 1031.  An exchange that does not comply with the safe harbor rules may or may not qualify for tax-deferred treatment.

The safe harbor is satisfied if an “accommodation arrangement” is made pursuant to which the following requirements are met (note: these are an abbreviated version of the most relevant requirements):

  • Title to both the replacement and the relinquished properties are held by an independent qualified accommodator.
  • The taxpayer has a bona fide intent that the property so held is either replacement or relinquished property that is intended to qualify for tax deferment.
  • No later than 5 days after the accommodator takes title to the replacement property, the accommodator and the taxpayer enter into a written agreement that provides that the accommodator is holding title to the replacement property for the benefit of the taxpayer in furtherance of a section 1031 tax-deferred exchange.
  • No later than 45 days after title to the replacement property is transferred to the accommodator, the taxpayer identifies the property to be relinquished.
  • No later than 180 days after title to the replacement property is transferred to the accommodator, the title is transferred again, this time to the taxpayer.
  • A final step also contemplated is that the relinquished property is transferred to the taxpayer’s buyer.

The regulations and procedures prescribed by the IRS for reverse exchanges are complex and reason to employ the services of a Texas property exchange expert in any such transaction. If you are planning to sell and acquire investment property, contact the experienced experts at Brazos 1031 Exchange Company, LLC.

How a Delayed 1031 Exchange Works

By following the procedures prescribed by IRC Section 1031, an investor can defer paying capital gains tax when selling investment property and can transfer all of the equity in the investment property (the “relinquished property”) into a new property (the “replacement property”).

To defer capital gains tax, the investor or “taxpayer” must avoid the receipt, or even the possibility of receipt (which is called “constructive receipt”), of the proceeds from the sale of the relinquished property. This is done by using an independent party (called a “qualified intermediary”), such as Brazos 1031 Exchange Company, to facilitate the exchange. The intermediary may not be the taxpayer’s attorney or real estate agent.

The simplest type of Section 1031 tax deferred exchange occurs when the taxpayer sells the relinquished property and acquires the replacement property at the same time.  In fact, both closings can occur on the same day.

But what happens when the taxpayer finds a buyer for the property to be relinquished, but has not yet located a replacement property to complete the exchange?  By following the following steps, a delayed tax deferred exchange can be accomplished.

  • The taxpayer enters into a sales contract with the buyer of the property to be relinquished.
  • The taxpayer assigns its position in the contract to the intermediary.
  • The buyer pays the purchase money to the intermediary.
  • The taxpayer deeds the relinquished property directly to the buyer.
  • The taxpayer notifies all parties of the identity of the replacement property within 45 days thereafter.
  • The taxpayer enters into a purchase contract with the seller of the replacement property.
  • The taxpayer assigns its position in the contract to the intermediary.
  • The intermediary pays the purchase money to the seller out of the funds the intermediary received from the buyer of the relinquished property.
  • The seller of the replacement property deeds the property directly to the taxpayer within 180 days after taxpayer deeds the relinquished property to the buyer.

In order to ensure your transaction is fully tax-deferred, you should look to exchange “up” in value, meaning that the market value of the replacement property is greater than that of the relinquished property, and any debt associated with the replacement property is greater than that of the relinquished property.

A Texas property exchange expert can guide you through the requirements of properly structuring your transaction. If you or someone you know is about to sell investment property contact the experienced experts at Brazos 1031 Exchange Company, LLC.

The 1031 Tax-Deferred Exchange: An Introduction

If a real estate investor sells property for more than what the investor paid for it, and then invests the sale proceeds in a new property, the investor incurs liability for capital gains tax on the profit. However, the investor can avoid the tax liability by taking advantage of an important provision in tax law.  With the help of a Texas property exchange expert like Brazos 1031 Exchange Company, the investor can accomplish a “Section 1031 tax-deferred exchange.”

Section 1031 is the Internal Revenue Code section number that permits qualifying business people and investors to defer their taxes when disposing of certain property, and then acquiring new property that is “like kind.” Like kind refers to the basic nature of the property, which essentially means that real property can be exchanged for real property. Likewise, personal property can be exchanged for personal property.

The theory behind this law is that when an investor disposes of investment property, only to roll the profit into a replacement, the investor’s economic position hasn’t really changed. The investor hasn’t converted the investment to cash, but only transferred that investment to another property of the same nature. Deferring capital gains liability enables the investor to build wealth.  It prevents the dissipation of capital and promotes its further investment.

The property involved must be held for business or investment purposes, and not primarily for sale. This excludes, for example, a house built by a contractor or a dealer in real estate who intends to sell it as inventory. A local property exchange expert can guide you through the requirements of properly structuring your transaction.

The 1031 exchange provisions allow the investor to defer paying taxes on the gain until the investor ultimately disposes of the investment without exchanging it for another like-kind property. At that time, the original deferred gain and any other gains realized later on replacement property will be subject to tax.

An investor who wishes to do a 1031 exchange must (i) locate and identify the new like-kind property within 45 days after the day the investor relinquishes the earlier investment, and (ii) take title to the new property within the earlier of 180 days or the due-date of the investor’s tax return for the year in which the relinquishment occurred.

The investor will be subject to current tax to the extent the investor receives property that is not like-kind, such as cash, or to the extent the loans on the property acquired are less than those on the property transferred.

Practically speaking, the use of a qualified intermediary is required to facilitate a tax-deferred exchange. All of these technical requirements can be professionally overseen by an experienced Texas property exchange expert such as Brazos 1031 Exchange Company, LLC.

What does a 1031 Exchange accomplish?

Section 1031 of the Internal Revenue Code enables investors and business owners to take advantage of a tremendous vehicle to build wealth and defer tax obligations. By completing a 1031 exchange, the taxpayer can sell investment property, and use all of the equity from the sale to acquire other investment property, without having to immediately pay taxes on the gain from the property sold.

The IRS requires that any taxpayer taking advantage of Section 1031 retain the services of an independent Qualified Intermediary (like a trustee) to facilitate the exchange. A Qualified Intermediary, like Brazos 1031, must be hired before the sale of the currently owned investment property.

At Brazos 1031 Exchange Company, we act as qualified intermediary / exchange accomodator for real estate investors and companies doing 1031 real estate exchanges throughout Texas.