What is a 1031 Tax-Deferred Exchange?

What are capital gains taxes?

The Federal capital gains tax rate currently (2008) is 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets. Those in the 10% and 15% tax brackets are charged 5%, and those under these tax brackets are not charged.

State capital gains tax rates vary from 0% in no-income-tax states (Alaska, Florida, Nevada, New Hampshire, Tennessee, Texas, Washington, and Wyoming) all the way up to 12% in North Dakota. They also vary according to the same tax brackets as listed for Federal taxes. It is easy to find out the capital gains tax rate of the state the property is in by entering a quick search on-line.

The capital gains taxes are paid for the year in which the gain is received, under most circumstances, the most common exception being a failed exchange that passed the end of the calendar year before funds were given to the taxpayer yet the taxpayer's intentions were to postpone payment of the taxes. State capital gains taxes are paid to the state in which the property exists. Also, depreciation declared against the relinquished property on a taxpayer's tax declaration must be repaid to a certain degree after relinquishment of the property. Services of a tax attorney or CPA are essential for these types of matters, and no information given by a QI or RealtyNet Advisors is to be considered professional advice in addition to or in place of the services of the tax attorney or CPA.

Capital gains are figured after determining the basis of the property by subtracting the original purchase price, improvement costs, etc. There are various factors and figures that formulate exactly what amount is considered capital gain, which a good tax attorney or CPA can establish for the taxpayer.

What is a 1031 Tax-Deferred Exchange?

A 1031 exchange is simply a method by which a real property owner disposes of real property and acquires more without having to pay capital gains tax on the transaction. In an ordinary sale transaction, the property owner is taxed on any gain realized by the sale of the property, as well as paying the recapture of previously taken depreciation. In an exchange, the tax on the exchange is deferred indefinitely, and only paid when an exchange is no longer made after relinquishing an investment property, or after the taxpayer (and spouse, if applicable) dies and the estate is sold.

What types of 1031 Exchanges are there?

The most common of 1031 exchange is the forward exchange, when real property is relinquished, sold, or otherwise disposed of, and then another real property or a combination of real properties are purchased as replacement. These are called by the IRS Code 1031 "relinquised" and "replacement" properties. The services of a Qualified Intermediary or Accomodator are required, under the IRS Code in Section 1031.

The next is the reverse exchange, which is growing in popularity, wherein the replacement property(ies) is purchased before the relinquished property is sold. This is done when the replacement property is purchased before the relinquised property is sold, and/or when an improvement to the replacement property is to be done. The services of a Qualified Intermediary are also required for this type of transaction, and many times the services of a financial lender are required, also. There are strict timelines for these exchanges, also, from the IRS code.

Frequently the cost of the replacement property(ies) does not match identically with the gain realized from the sale of the relinquished property. The funds remaining, or the personal property or mortgage notes received which are not put into the replacement property(ies) of, which must be of like-kind to qualify, are charged capital gains taxes during the tax year of receipt. To avoid this, investment of remaining funds into a portion of a TIC property can be made. RealtyNet Advisors can help investors finds real property TIC investments to match their needs and funding.

All types of 1031 exchanges must adhere to the 45 days identification and 180 day completion deadlines of the Code. Selection of a good, knowledgeable, trustworthy Qualified Intermediary service is of vital importance. It is also very wise to identify more than one property during the 45 day identification period, so that the investor has a back-up in case the closing of the original property fails for some reason. Identification of pre-screened TICs is a wise strategy for 1031 exchangers.

For more information, please email us at info@realtynetadvisors.com (link) or call us at 800-872-1031.

What happens if the exchange is not completed within the 180 day period?

If the identified property(ies) is not closed on by the 180th day since the closing date of the relinquised property, then the money held in trust by the Qualified Intermediary are returned to the client, and the client must pay capital gains taxes for those funds for the year in which the funds were received, as long as intention is clearly shown. An investor cannot use the 1031 exchange code to defer payment of taxes to the next year, when receipt of the money is made in the following year. The deferment is given only if the true intention of the investor was to close on the identified property(ies) and that is not able to happen before the 180 day period ends in the next calendar year, and the first property was relinquished in the previous calendar year.

How does the IRS treat 1031 exchanges?

A 1031 exchange is authorized by Section 1031 of the Internal Revenue Code. Careful adherence to the requirements of Section 1031 is important in maintaining the tax-free status of the transaction. As qualified intermediaries, our company's experience can guide you through the IRS's regulations, making a 1031 exchange easy, inexpensive, and safe.

Please email us to receive a 24-page pamphlet entitled "Section 1031 Tax Deferred Exchanges in a Nutshell”, or continue exploring our site.

For more information, please email us at info@realtynetadvisors.com or call us at 800-872-1031.