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What is a 1031 Tax Deferred Exchange?

A tax deferred exchange is a tax shelter that permits an investor to sell an investment property without triggering capital gains tax liability.  Thus the owner has additional capital available to purchase a replacement property.  Payment of the tax is deferred until the final disposition of all investments.  In other words, when the investor sells off the last investment property and keeps the cash rather than replacing it with another property. 

The primary advantage of a 1031 exchange is that, through the deferment of capital gains taxes, the Exchangor is able to acquire more valuable and/or more leveraged investment property in improve their investment returns.  If it is the intent of the taxpayer to reinvest the proceeds from one property into another, the 1031 exchange remains the only vehicle remaining for full tax deferment.

The disadvantage is that the funds MUST remain invested. 

An investor MUST use a Qualified Intermediary to handle the exchange.  In short, the Exchangor (owner) of the property can sell it but cannot "handle" the funds e.g. deposit them in their own account or have the funds payable directly to the investor in any manner otherwise it may trigger a taxable situation.  There are professional companies, attorneys, title companies, accountants and many others who can serve as an intermediary.  Contact your Realtor for advice and direction here. 

Issues to consider when choosing a  a Qualified Intermediary:

Are the already disqualified?
What are the chances of bankruptcy?
Do they have a fidelity bond (insurance) to protect you in the case of misappropriation of funds?
In case of injury or death, is there a back up?
How in depth is their exchange agreement?
How are the funds deposited?
How quickly can the funds be released?
What is the fee structure?  Hidden fees?
Do they pay interest on the proceeds held?
Are the a member of the FEA (Federation of Exchange Accommodators)? www.1031.org.

What are the qualifications of like-kind Property?

It is important to choose "like-kind" property.  Like-kind refers to the intended purpose of the property rather than the exact description of the property.  Like-kind property would be real property held for investment purposes, trade, or business.  Therefore, the exchange of a rental house for a retail center is considered like-kind.

Properties that are not like-kind:

1) stock in trade or other property held primarily for sale; 2) stock, bonds, or notes; 3) other securities or evidences of indebtedness; 4) interests in a partnership; 5) certificates of trust of beneficial interest.  The property must also be in the United States.

Ten Considerations when completing a 1031 Exchange:

1) Consult with a CPA and/or Tax Attorney.
2) The Exchange Addendum should be added to the Buy/Sell contract.
3) Qualified Intermediary should be notified.
4) Add the Qualified Intermediary to the title work delivery list.
5) Establish the Exchange Agreement with the Qualified Intermediary (QI).
6) Inform the QI of the closer or title company contact.
7) Attend the closing and make sure that the proceeds go to the QI.
8) Send your list of identified replacement property(ies) to the QI by the 45 day deadline.
9) Send the Assignment of Contract Replacement Property to the QI prior to closing the replacement property.
10) Make sure that the QI has transferred the proceeds to the closer of the replacement property and that there is NO CASH BACK TO THE BUYER!

For more information contact me at 303-229-6485 or tomstudebaker@bodinrealty.com