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Investors buy real estate to earn a profit. Decisions are carefully made to
determine the effects of location, potential rents and expenses, financing and
a multitude of other important factors in an attempt to realize much of a
profit as possible. Once the profit is made, the typical investor sells his
property, pays his taxes and reinvests in other real estate. The vast majority
of real estate investors seldom make use of one of the most valuable techniques
for increasing and preserving profit we have available: The tax deferred
exchange.
Timeframe: From the time of closing on their relinquished property, the
investor has 45 days to nominate potential replacement properties and a total
of 180 days from closing to acquire the replacement property.
Set up: The exchange must be set up prior to the closing of the investors
relinquished property. The investor cannot have actual or constructive receipt
of the funds. The investor or their agent should contact an Exchange
Accommodator as soon as possible to begin setting up the exchange and also
inform Escrow of their intention to complete a 1031 exchange.
Identification requirements: The investor must ID the replacement property
prior to midnight on the 45th day. The investor normally nominates three
potential properties of any value. Then, acquires one of these three properties
within 180 days. Typically, a common address (unambiguous description) will
suffice. It is also a good idea to have a pending offer. If the investor needs
to identify more than three properties, then the combined values of all
properties cannot exceed 200% of the relinquished property's value.
Values: In order for an investors exchange to be completely tax deferred, the
value and equity of the replacement property should be equivalent to or higher
than that of the relinquished property. Investors can decrease mortgage levels
by bringing cash into the replacement property, but they cannot increase
mortgage levels and take cash out of the transaction without a tax implication.
If they take cash out or go down in value on their replacement, then they would
pay taxes on a portion of the transaction.
Title: It is very important to review how title is held on the investors
relinquished and replacement properties and consider potential financing
requirements. The vesting needs to be consistent, in order to maintain the IRS
continuity of vesting requirement.
Present exchange laws are based upon tax provisions dating back to 1921.
Subsequent code changes, tax court rulings, and Revenue Rulings have created a
set of clear, concise guidelines for performing defensible tax deferred
exchanges. Judicial decisions made in 1979 and the 1984 Tax Reform Act added
the concept of the delayed exchange. It is possible to sell your property today
and complete your tax-deferred exchange in six months. By using the technique
of the "reverse exchange" your may acquire a property today and sell the
property you no longer wish to own in the future while still deferring taxes on
the sale.
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