How Can A 1031 Exchange Work For Me?

By
Real Estate Agent with Keller Williams Florida Partners

The Section 1031 Exchange should be the tool of choice for real property owners who wish to defer taxes when property is sold. Professionals, such as attorneys, accountants, financial advisors, and real estate professionals should understand the benefits Code Section 1031 of the Internal Revenue Code will provide as a value-added service to their clients.

A 1031 exchange can defer the capital gain taxes that are due when you sell property that has increased in value or been depreciated for tax purposes. These federal and state capital gain taxes can be costly.
Section 1031 of the U.S. Internal Revenue Code allows investors to defer capital gains taxes on the exchange of like-kind properties. 1031, or tax-deferred, exchanges hold great advantages for real estate investors.

In a typical transaction, the property owner is taxed on any gain realized from the sale. However, through a Section 1031 Exchange, the tax on the gain is deferred until some future date. In the most common type of exchange, property is sold and the proceeds are used to purchase replacement property within certain timeframes.

To qualify for a safe harbor tax deferral, proceeds should be held with a Qualified Intermediary between the sale and purchase. The QI is a 1031 exchange Intermediary or entity that can legally hold funds to facilitate a 1031 exchange. To be qualified, the 1031 exchange intermediary must not be relative or agent of the exchanging party. As an exception, a real estate agent may serve as a 1031 exchange intermediary if the current transaction is the only instance in which the agent has represented the exchanging party over the past two years.

The use of a Qualified 1031 Exchange Intermediary is essential to completing a successful 1031 exchange process. The QI performs several important functions in the 1031 exchange process including creating the exchange of properties, holding the 1031 exchange proceeds and preparing the legal documents.

Prior to closing of the relinquished property, the decision to exchange must be made. The exchange agreement must be in place and delivered to all parties before the relinquished property transfer of title.

The replacement property needs to be identified within 45 days of closing on the relinquished property and the replacement property needs to be purchased within 180 days of closing on the relinquished property or the date the taxpayer's tax return is due, whichever date is first.

In their 1031 exchange, many investors benefit from buying investment property as Tenants In Common (TIC) because it completes their exchange and can be closed in a timely manner due to pre-arranged financing.
Investors considering the sale of investment or income property should first consult their financial or tax advisor to determine if a tax-deferred exchange will benefit their long-term investment goals and retirement plans.

1031 exchanges ensure maximum return on investments to people of all financial backgrounds. Paying capital gains taxes or exempting oneself with a 1031 Exchange is the choice you face. Ultimately, the investor must decide whether to take advantage of a 1031 exchange or write a check to the IRS!

Comments (3)

Daniel Odio
DROdio Real Estate, Inc - Alexandria, VA
Mike, Peggy,

I'm just launching a new 1031 calculator and I'd love to get your feedback on it.

It's at www.1031summary.com

Let me know what we could do to improve on it.  Constructive comments would be appreciated.  I'm also considering the possibility of co-branding it, so let me know if that would be interesting to you.

Also, for 1031 advice, the best 1031 attorney I've met is a guy named James Brennan.  He's the 1031 expert from Wachovia.  You can find his ActiveRain profile here and he's great at answering questions.  His website is www.Inside1031.com

Regards,

DROdio

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Jan 23, 2007 02:06 PM
Anonymous
Scott

The best way to defer capital gains is to use 1031 exchanges, but as this article describes, "It's a tedious process and not many people know how to work the deal."

Defer'Em is the best resource for being able to understand the confusion - boot, taxable gain, deferred gain, and new cost basis - and it has a tool you can use to generate IRS Form 8824 for reporting Like-Kind Exchanges on your tax return. Defer'Em is a guided approach that helps you optimize deferrals using all deductible closing costs and exchange fees, and it also generates an Exchange Report which will help you visually understand all the elements of your 1031 exchange. 

Another tool that is very useful is Depreciate'Em, which accelerates depreciation by segmenting deductions, resulting in substantial tax savings. I came across both of these tools when I was reading a Forbes.com article about how landlords often miss major savings.

It's really nice to find resources like these that can help you learn and take advantage of tax-saving opportunities. I had a lot of difficulty understanding depreciation and 1031 exchanges, and even more difficulty reporting them, but tools like these make it very simple for anyone to do

Jul 04, 2007 08:14 AM
#2
Ed Vogt
Midwest Properties of Michigan - Grandville, MI
Grandville, MI Midwest Properties
I'm newer in RE and am just starting to hear the 1031 talk. I have investor/clients that need to know these things.  I was clueless as to what it is, but have been reading several informative posts (such as this) that are helping me understand.  Thanks!
Aug 22, 2007 12:42 AM