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1031 Tax Deferred Exchanges
“ No gain or loss shall be
recognized on the exchange of property held for productive use
in a trade or business or for investment if such property is
exchanged solely for property of like-kind which is to be held
either for productive use in a trade or business or for
investment.”
By
using an exchange the investor is able to defer the capital
gain taxes that would otherwise be incurred on the sale of
investment property. The investor can then use the entire
amount of the equity to purchase substantially more
replacement property. A “qualified intermediary” is normally
involved in a properly structured exchange.
In
order to qualify for Tax Deferred Exchange, there are some
steps that should be followed according to Internal Revenue
Code Section 1031.
Here are eight simple steps to a
typical 1031 Tax Deferred Exchange
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Discuss with tax advisor intentions and objective of the
exchange prior to close/final settlement of the Relinquished
Property and discuss the basic guidelines of IRC Code 1031.
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Show exchange intent language in Sale Contract and notify
Buyer that rights under the contract will be assigned to a
qualified exchange intermediary.
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Enlist the services of a qualified intermediary such as
Equity Preservation, Inc. prior to close/final settlement of
the Relinquished Property to avoid constructive receipt of
the proceeds. Check references carefully, not all
intermediaries are alike in services, reputation and
reliability. Fee quotes do not tell enough about the
intermediary.
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Become familiar with the identification rules and
regulations set by the IRS to identify the Replacement
Property(ies) within 45 days after close of the Relinquished
Property.
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Enter into contract on Replacement Property and indicate
exchange intent language in contract. Notify Seller that
rights under the contract will be assigned to the qualified
intermediary. Contract must allow for closing within the
allowable exchange period.
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Contact the settlement agent for the Replacement Property,
placing them on notice of the intent to acquire the property
under the provisions of a 1031 tax deferred exchange. Also
furnish them with the name of the intermediary.
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Notify the intermediary as to which Replacement Property(ies)
among the identified properties were chosen to be acquired
and if any earnest money deposits are required. Schedule
closing the Replacement property no later than 180 days from
the close of the Relinquished Property, or the tax return
filing date, whichever occurs first.
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Review any and all documentation for the transaction
thoroughly. Provide accountant with the final closing
statements from the Relinquished Property and Replacement
Properties for preparation of the appropriate forms to
report the exchange on
Federal & State tax returns.
Situations to Discuss with Tax
Advisor prior to Executing an Exchange:
Transaction with receipt of cash, notes or mortgage relief
(“boot”)
Transactions between related parties Vesting vs. tax reporting
Vesting vs. tax reporting
At-risk capital rules
Repossessed properties, probate sales and bankruptcy sales.
Construction of replacement property.
Out of state transaction
Depreciation recapture rules
Equity sharing/shared finance arrangements.
\Installment sale rules on seller carryback notes
Financing requirements
Any payment/distribution made to the taxpayer or a third party
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