1031 Exchange

The following is provided as a courtesy to assist in understanding the benefits of home ownership only. The Shire Real Estate Group and its agents cannot and does not provide tax advice. For tax information or questions, you should obtain advice from a professional tax advisor or a CPA.

What is an IRC 1031 Tax Deferred Exchange?

An Internal Revenue Code 1031 Tax Deferred Exchange is a transaction in which the taxpayer trades investment property (relinquished property) for substitute investment property of equal or greater value (replacement property).

A 1031 Exchange provides one of the best shelters for deferring capital gains tax. By utilizing the 1031 Tax Deferred Exchange, the taxpayer has the ability to reinvest the proceeds from their relinquished property into a like-kind replacement property without recognizing any gain.

Choosing the Best Intermediary

One of the most important decisions the taxpayer has is the selection of a qualified intermediary. The intermediary is the party to the exchange that assists the taxpayer in completing an exchange. The IRS has defined the role of the intermediary under the safe harbor rules as stated in the IRC regulations. Choosing a responsive and professional qualified intermediary is paramount to a successful exchange.

John is always ready to assist you in your exchange and assist you as your professional and qualified intermediary.

What language should I put in the Sales Contract?

"Buyer hereby acknowledges it is the intent of the seller to affect an IRC Section 1031 tax deferred exchange which will not delay the closing or cause additional expense to the buyer. The seller's rights under this agreement may be assigned to a qualified intermediary for the purpose of completing such an exchange.

Buyer agrees to cooperate with the seller and Named Intermediary in a manner necessary to complete the exchange."

Relinquished Property

(First leg or sale transaction)

Typically, the taxpayer has already entered into a purchase and sale agreement to sell the relinquished property. Prior to the closing the Intermediary and the taxpayer must enter into an ecxhange agreement, which describes the duties and responsibilities of the parties to the exchange.

Additionally, the Intermediary will provide an assignment of the taxpayer's interest to be signed by all parties to the transaction. Once the intermediary's documents have been signed, escrow can then close and transfer the proceeds.

Identification of Replacement Property

The Taxpayer has 45 days from the close of the relinquished property in which to identify replacement property. When identifying replacement property, you have a choice between two rules:

First Rule:
The first rule is known as the three-property rule. The taxpayer may identify a maximum of three (3) replacement properties without regard to fair market value.

Second Rule:
This rule is known as the 200% rule. When identifying more than three (3) properties, the total aggregate value of all properties identified cannot exceed 200% of the relinquished property value (see example below).
Relinquished property sold for $200,000
2 x $200,000 = $400,000

(The taxpayer can identify a maximum of $400,000 in replacement properties).
Example: Value:

1. 123 Main St., Fullerton CA $75,000
2. 1031 USA Ave., Brea, CA $125,000
3. 55 Center St., La Mirada, CA $65,000
4. 1212 Market St., Fullerton, CA $135,000

Total Value Listed = $400,000

Replacement Property

(Second leg or purchase transaction)

Once the taxpayer has located a "like-kind" replacement property, the intermediary will be assigned into the contract / escrow instructions as the Buyer. When this transaction is ready to close, funds held will be deposited into escrow to fund the closing. Should escrow require additional funds to close, the taxpayer can deposit funds directly into escrow. The replacement property must be acquired on or before the following dates:
  1. 180 days from the date of the transfer of the relinquished property, or
  2. The date the tax return is due for the tax year in which the relinquished property is transferred (the taxpayer had the right to request an extension to file their tax return, however, the entire exchange transaction cannot exceed 180 days).

Like Kind Property

Pursuant to internal Revenue Code 1031, "like-kind" property is any real property held for the productive use in a trade or business or for investment purposes. Neither the relinquished property nor the replacement property can be the taxpayer's principal residence. Please note that with a personal property exchange, like-kind means identical property.

For example: A commercial truck for another commercial truck, dental equipment for dental equipment.

Disbursement of Exchange Funds

The rules of an exchange allow the taxpayer access to the exchange funds only upon the following conditions:
  1. Exchanger has purchased all the replacement property identified and the identification period has expired.
  2. Exchange has not identified any replacement property within the 45-day period.
  3. The 180-day exchange period has elapsed.

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