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FAQ
FAQs
What is a Tax
Deferred Exchange?
A tax
deferred exchange is simply a method by which a property
owner trades one or more properties for one or more
other properties without having to pay any federal
income taxes on the transaction, and often with no state
incomes taxes. In an ordinary sale transaction, the
property owner is taxed on any gain realized by the sale
of the property. But in an exchange, the tax on the
transaction is deferred until some time in the future,
usually when the newly acquired property is sold.
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Who can do an Exchange?
Exchanges can be done by individuals, trusts, corporations,
partnerships, limited liability companies, or any other
business entity.
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What are the Disadvantages of an
Exchange?
The
taxpayer must reinvest the net proceeds from the
disposition of the relinquished property in like kind
property rather than other types of more liquid
investments, such as stocks or bonds. There may be
additional escrow fees, attorney's fees, accounting
fees, and the intermediary’s fees. The replacement
property will have a carryover tax basis from the
relinquished property. This means that more taxable gain
will be realized when the replacement property is sold
than would have been realized if the replacement
property had been acquired through a straight sale and
purchase. There will also be less depreciation
deductions if the replacement property is depreciable.
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How is an Exchange
Structured?
Exchanges may be simultaneous or delayed. In a
simultaneous exchange with a qualified intermediary, title to the
relinquished property is transferred to the buyer. The
buyer pays cash to the qualified intermediary. The
qualified intermediary
pays cash to the seller who transfers title to the
replacement property to the taxpayer. In a delayed
exchange, the taxpayer has 45 days to identify the
property he or she wants as the replacement property.
The taxpayer must acquire that replacement property
within 180 days of the transfer of the relinquished
property (or the due date of the taxpayer's federal
income tax return (including extensions) for the year in
which the relinquished property was transferred). There
are no extensions or exceptions to these time limits.
The other requirements of the IRS regulations must also
be met.
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How are the Exchange
Funds Invested?
If you
actually or constructively receive the exchange
funds, the exchange will be taxable. Therefore, the exchange funds must be held by the
qualified intermediary, or an unrelated third party
escrow or trustee. All exchange funds held by 1031
Services, Inc. are placed in qualified escrow accounts
with an independent bank. We do not commingle
your exchange funds with the funds of any other client
for investment purposes. The account is a money
market account with daily liquidity and is
FDIC insured for up to $250,000. It
may bear interest depending on current market conditions
and the amount of the deposit.
For more information, see
"Why are Your
Exchange Funds Secure With Us?".
You receive a monthly bank statement
and 1099-INT directly from the bank. For an
additional bank charge, you may also have the option of viewing
your account on-line at the bank's website. The
account requires your signature
to the bank for any
withdrawals. We can also work with the bank of
your choice, but an additional account set up fee will
apply.
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What are the Requirements of an Exchange?
There are several requirements for a valid exchange.
1.
Types of Property.
In general, all property, both real and personal, can
qualify for tax-deferred treatment. However, some types
of property are specifically disqualified, namely:
property held primarily for sale; stocks, bonds or notes
and REIT interests; other securities or evidences of
indebtedness or interest; interests in a partnership;
certificates of trusts or beneficial interest; and
chooses in action (e.g. interests in lawsuits).
2.
The Purpose Requirement.
The taxpayer's relinquished property and replacement
property must be held for productive use in a trade or
business or for investment. Property acquired for
immediate resale will not qualify. Property held or
acquired as a principal residence or primarily as a
vacation home will also not qualify.
3.
The Like Kind Requirement.
Replacement property acquired in an exchange must be
"like-kind" to the property being relinquished. All real
property is like-kind to other real property. But real
property is NOT like-kind to personal property.
4.
The Exchange Requirement.
IRC §1031 specifically requires that an exchange take
place. That means that property must be exchanged for
other property, rather than sold for cash. The exchange
distinguishes an IRC §1031 tax deferred transaction
from a taxable sale and purchase. Today, deferred exchanges are
accomplished through qualified intermediaries to insure that they
meet the exchange requirements of IRC §1031.
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How
do the Identification Rules Operate?
Identification of all replacement property must be made
in writing, signed by the taxpayer, and
sent to a party to the exchange on or before midnight of
the 45th day of the exchange period. The written identification is usually sent
to the qualified intermediary. The identification must be specific
as to what the taxpayer intends to purchase. All
identifications must give either the street address or
legal description of the property and state that the
taxpayer is identifying it as replacement property. If
improvements are to be constructed on the property, they
must be described in as much detail as is reasonably
practical.
The
taxpayer may identify one or more properties in the
written identification. In general, the number of
replacement properties that may be identified is:
1).
Up to three properties, without
regard to their fair market value
(The Three-Property
Rule);
2).
More than three properties,
but the total fair market value of all these properties
at the end of the 45-day identification period does not
exceed 200% of the total fair market value of all
properties relinquished in the exchange
(The
200% Rule).
Any
property actually received during the 45-day
identification period is treated as properly identified,
but does count as a property for the purposes of the
Three Property Rule or the 200% Rule if the taxpayer
identifies additional replacement property in a written
notice. If the taxpayer exceeds both the Three-Property
Rule and the 200% Rule, then the properties acquired
after the 45th day do not count as replacement property
in the exchange (unless the taxpayer acquires 95% of all
the identified properties).
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How is
Taxable Gain Computed in
an Exchange?
As a GENERAL rule of thumb, you must
trade up or equal in value AND equity to totally defer
the taxable gain in your exchange. HOWEVER, there
are many exceptions to this rule and your taxable gain
can be impacted by closing costs, including rent
prorations and security deposits. Your taxable
gain also can be impacted by several tax provisions,
including depreciation and other recapture items, net
operating losses, and special corporate and partnership
tax provisions. We do not review your tax returns
for items that may affect your taxable gain, and we do
not undertake to calculate taxable gain in your exchange. YOU SHOULD CONSULT YOUR TAX ADVISOR PRIOR TO
COMMENCING THE EXCHANGE REGARDING THE COMPUTATION OF
POTENTIAL GAIN FROM THE EXCHANGE AND ANY SPECIAL TAX
ITEMS THAT MAY IMPACT YOUR TAX CONSEQUENCES.
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