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1031
Exchange When a property is sold, the seller has to
pay tax (capital gain tax) which depends on the property appreciation
in value from the time of purchase.
However, if after the sale of the
property, a different new property is purchased, tax payments (capital
gain tax) may be deferred. This clause is present in the Section
1031 tax deferred exchange (Tax Free Exchange). A person
may sell one property and purchase multiple properties or consolidate
by selling multiple properties and purchase one.
The types of properties that are eligible for the 1031 Exchange are
any property utilized for productive use in a trade or business or for
investment, such as an apartment building, equipment, empty land or
shopping center.
To qualify for the 1031
Exchange several requirements have to be met:
1. The new property must be equal to
or greater in value than the old property.
2. The equity in the new property
must be equal to or greater than that in the old property.
The taxpayer may identify a
maximum of three (3) replacement properties without regard to fair
market value. When identifying more than three (3) properties, the
total aggregate value of all properties identified cannot exceed
200% of the amount of sale price).
Example: Relinquished property
sold for $200,000.00 2 x $200,000 = $400,000.00
The Taxpayer can identify a maximum of $400,000 in
Replacement Properties
All net proceeds from the sale of
old property must be used for purchase of a property.
Make sure that the real estate
contracts have the 1031 terminology in the contract that allows for
the assignment & indicates your intent to do an exchange.
Sample Terminology for Real Estate Contracts
(Taxpayer should consult their tax advisor or real estate professional
as this is suggested language only):
“Both the Seller and the Buyer hereto agree
to cooperate with each other in a manner necessary to enable either
party to qualify for a IRC Section 1031 tax-deferred exchange at no
additional cost or liability to either party. Either party’s rights
and obligations will be assigned to Investment Exchange Group to
facilitate such exchange.”
Until a new property is purchased, the funds received from the sale
of the property are held by a Qualified Intermediary (also known as an
Accommodator or Facilitator) and not escrow, CPA, attorney, or
broker.
Important Deadlines
Identification Period: Day 0 - 45.
During this period of time from the date of closing on the old
property, a list of new potential properties has to be identified.
Exchange Period: Day 0 – 180.
During this period of time, the investor has to close on
one or more replacement properties. Alternatively, an exchange must be
finalized before the date the tax return is due for the tax year in
which the replacement property is transferred (the investor may
request an extension).
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