I. WHAT IS A 1031 EXCHANGE?
A. History of tax deferred exchange §1031 Internal Revenue Code
1. The Revenue Act of 1918 and 1921
2. The Revenue Act of 1924: eliminated non like-kind exchanges.
3. 1970's Starker Exchange: beginning of delayed exchange
4. The Revenue Reconciliation Act of 1989 - only within the United States
B. Applies to business use and investment properties
C. Includes rental, land, residential, industrial and commercial real estate
D. Provides safe and legal procedure for rolling sales profits into new property as a non- taxable event.
E. It is not a "swap".
"Non like-kind' property; taxable to the extent there is capital gain
B. Constructive receipt
Although an investor does not have actual possession of the proceeds, they are legally entitled to the proceeds in some manner such as having the money held by an entity considered as their agent or by someone having a fiduciary relationship with them. This creates a taxable event.
C. Direct deeding
E. Exchange agreement
F. Exchange period
G. Identification period
1. 45 days
2. In writing
3. No extensions
4. Identification rules
a. Three Property Rule
The Exchanger may identify a maximum of three (3) replacement properties without regard to the fair market value of the properties.
b. 200% Rule
The Exchanger may identify any number of properties so long as the aggregate fair market value of the relinquished properties.
c. 95% Rule
The Exchanger may identify any number of properties without regard to the aggregate fair market value so log as Exchanger receives 95% of the aggregate fair market value of all identified replacement properties prior to the end of 188-day period.
H. Total exchange period
1. 180 days or day tax return is due (whichever is sooner)
2. Calendar days
3. No extensions available
I. Improvement Exchange
The improvement (also called a construction or build to suit) exchange allows an Exchanger, through the use of a Qualified Intermediary and Exchange Accommodation Titleholder (ET), to make improvements on a replacement property using exchange equity.
J. Like-kind exchange
"As used in IRC 1031(a), the words LIKE-KIND have reference to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under that section, be exchanged for property of a different kind or class. The fact that any real estate involved is improve or unimproved is not materials, for that fact relates only to the grade or quality of the property and not to its kind or class. Unproductive real estate held by one other than a dealer for future use or future realization of the increment in value is held for investment and not primarily for sale."
K. Mortgage boot
L. Qualified Intermediary
1. The entity that facilitates the exchange:
a. is not a related party, e.g., agent, attorney, broker.
b. receives a fee.
c. receives the relinquished property from the Exchanger and sells to the buyer.
d. purchases the replacement property from the seller and transfer it to the Exchanger.
M. Relinquished property
N. Replacement property
O. Reverse exchange
III. INTERNAL REVENUE CODE SECTION 1031
A. 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.
1. stock in trade or other property held primarily for sale
2. stocks, bonds or notes
3. other securities or evidence of indebtedness or interest
4. interests in partnership
5. certificates of trust or beneficial interests
C. Holding period issues - intent is critical issue
D. Section 1031 exchanges limited to property within the United States
E. Personal property exchanges
1. Must exchange within limits of same asset classification
2. Examples or personal property exchanges include:
a. business aircraft for business aircraft
b. livestock for livestock
c. restaurant Mexican gold coins for Austrian gold coins
d. equipment for restaurant equipment
F. Vacation/second homes - a grey area
G. Section 1031 exchanges between related parties - (2) year rule
H. Section 1031 and Section 121 combined - (5) year holding period
IV. INVESTORS CAN POTENTIALLY DEFER 100% OF THEIR CAPITAL GAIN TAXES, BOTH STATE AND FEDERAL
A. Emphasis placed on "deferred" not "free"
B. Section 1031 allows deferral of the gain.
However, upon a subsequent sale of property, the capital gain is deferred will be recognized unless another exchange is completed.
C. Section 1031 equals an interest-free, no-term loan from the IRS on the taxes due
V. TAXPAYER RELIEF ACT OF 1997 - IRC SECTION 121 - PRINCIPAL RESIDENCE
(Which house is the "principal" residence?)
1. Generally, the property the taxpayer uses in excess of six months per year will be considered the taxpayer's principal residence
2. Many factors are relevant in determining which home is the "principal residence" of taxpayers who own more than one home. Amongst them are:
a. place of employment
b. amount of time property is occupied
c. where other family members live
d. address used for tax returns
e. driver's license, car and voter registration
f. bills and correspondence and location of taxpayer's banks and clubs
g. primary banking depositories
VI. DELAYED EXCHANGE
A. Exchange equation: rules for full deferral
1. 100% proceeds
2. Equal or greater debt
VII. HOW TO SET UP EXCHANGE
IX. CHOOSING A QUALIFIED INTERMEDIARY
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