1031 Exchanges, tax deferring transactions have moved from a west coast invention to the east, and you should know more about them, if you own any kind of investment real property. In the landmark Starker decision in 1979, the United States Supreme Court substantiated the validity of the delayed exchange process. Prior to that time, the courts had never sanctioned an exchange whereby the relinquished property was sold and at a later date, replacement property was purchased. What this means to you as an owner of investment property, is that you can dispose of property in which you have sizable gain, but perhaps the headaches of management, and replace the old property with a different more manageable property, or even an ownership interest with others, in new property.
If done correctly, a 1031 Exchange can permit an investor to defer tax due in connection with the sale of real property, enabling the investor to consolidate, diversify, leverage or relocate her investment. Fortunately, in 1994, the Internal Revenue Service promulgated "Safe Harbor" regulations which provide the steps to take to make sure a 1031 Exchange produces the desired tax deferral. At Topkins & Bevans, we have always advised our exchanging clients to use a Qualified Intermediary. There have been some problems with intermediaries absconding with funds in the past, but never, ever, have there been problems with the Company we work with, OREXCO, an affiliate of Old Republic Title Insurance Company. In myriad transactions, we have been most satisfied with the level of expertise, service and financial integrity provided by that organization.
The key to a successful Exchange is identifying replacement property in a timely manner. It is essential that the investor locate "like-kind" property. Generally, real estate is like kind to all other real property, except foreign real property, as long as it is held for investment or the productive use in a trade or business. There is a 45 day time frame in which the investor must "identify" replacement property. Identifying the property on a timely basis is not all that must be done. It is also essential to "close" on the identified property in or within no longer than 180 days from the sale of the subject property. The 45 and 180 day periods are calendar days. There is no grace period if the day in question falls or a Saturday, Sunday or holiday.
Even if you own property with another investor, you may be able to exchange property if he or she does not wish to. In this type of transaction, you must clearly indicate and allocate each investor's interest in the property before you sell. The investor who wishes to exchange may do so, and the other investor may receive cash (taxable). It is, of course, very important that the investors be clear on their intentions before entering into an exchange agreement with the Qualified Intermediary. Once a relinquished property is closed where all exchanging properties are under one exchange agreement, the exchangers do no have an option of dividing proceeds and buying separate replacement properties.
It is also possible to enter into an exchange transaction where part of the tax is deferred and a portion recognized as taxable gain. If the equity in your investment property is $150,000,00, and you wanted to use only $100,000.00 to purchase your investment property, and take $50,000 out to buy a new car, you would have a partially tax deferred exchange. The $50,000 you took to purchase the car is considered taxable cash "boot".
Even is you live in one apartment, in the three family dwelling you own as an investment, you may be able to utilize a tax free exchange for the other two units. That type of approach works out extremely well if you are converting the investment rental property into condominiums for sale to third parties (See my previous post on this type of advantageous transaction). The unit you live in is sold as your principal residence, and you are eligible for the tax exclusion permitted for the sale of your principal residence where you resided for at least two of the last five years. The other two units can be sold as part of a 1031 Exchange, as long as the percentage of the value of the property is consistent with your past tax returns. This is a somewhat complicated area, and you should consult your tax advisor with regard to the particular aspects of this type of 1031 Exchange transaction.
I would be more than willing to communicate with you, and your tax advisor, to discuss any type of 1031 Exchange which you may be interested in. If you use a solid, reputable company like OREXCO as your Qualified Intermediary, you will have little, if any, risk about the safety of your funds. In these days of uncertainty, selecting the "right" Qualified Intermediary is more important than ever.
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