1031 TAX DEFERRED EXCHANGE
WHAT IT IS
The IRS permits you to "exchange" one property for another and defer state and federal taxes. This means when you sell your commercial property you can defer capital gains taxes if you use the proceeds from your first sale to buy a second business or income property.
HOW IT WORKS
Both properties must be of "like kind", i.e., held for productive use in a trade or business, or held as an investment. Basically that means you cannot exchange a personal residence for an income property.
TYPES OF 1031 EXCHANGES
There are two most commonly used types of 1031 Tax Deferred
1. The Simultaneous Exchange. In this case, the escrows on both properties - the "relinquished" one and the "replacement" one - are closed at the same time, and that the one is contingent upon the other.
2. The Delayed Exchange. Since it is often difficult to predict with certainty exactly when a complex real estate transaction will close, this method is often employed.
Here are the four rules that apply:
First, you have 45 days from the closing of the relinquished property to find up to three prospective exchange properties.
Second - as an option - you can identify a combination of properties. However, their combined fair market value cannot be greater than 200% of the value of the relinquished property.
Third, the first two rules don't apply if 95% of the value of all the
found properties are actually acquired.
Fourth, you have 180 days from the close of the relinquished property to close on the replacement property.
To take advantage of the delayed exchange method, you must engage the services of a professional exchange intermediary. This person will hold the funds from the relinquished property in a trust fund, and will purchase the replacement property used in the exchange. The intermediary also helps with the closing of the new property. Obviously you will want an intermediary who can guarantee the safety of the trust funds.
This information is provided in good faith as a summary of the Internal Revenue Code (IRC) Section 1031, and is intended to help you understand the concept. It is not intended to be a comprehensive or authoritative reference, and L&L Financial is not responsible for any informational errors or omissions. For a complete overview, please review the official IRS Code, or consult a tax professional.