1031 Exchange Lowdown

How To Defer 100% Taxes

We can defer some of the tax when we use a 1031 exchange. But to qualify for a 100% deferment of taxes, an investor must spend all of the net equity from the sale on the purchase of replacement property and acquire property with equal or greater debt on it as the relinquished property had prior to sale. Findarticles.com reports:

One exception to this rule is that investors can always replace any debt reduction with additional cash. Net equity is defined as equity less mortgage debt and exchange expenses. Exchange expenses do not include all closing costs however. Exchange expenses are defined as those expenses one typically incurs in connection with the purchase and sale of real estate.

Read more: Commonly asked questions about 1031—Part 2

The Long Wait

This is the toughest part if you are not just a mere dabbler in the business of 1031 exchanges. Plan to buy and sell property and make use of 1031 exchange provisions regularly? Then, one of the first things you need to know is how long you can hold on to the property before you exchange. The rules don’t specify any particular holding period, which will automatically qualify or disqualify an investor for an exchange.

One requirement for qualification is that you must hold a property for use in a trade or business or for investment. There are eight separate factors that help decide if a taxpayer is holding property for the purpose of investment. Holding period is one of these factors. Many legal and tax advisors believe that a one-year holding period is sufficient enough to establish investment intent. And during this period, you should not have engaged in resale activities.

I would, however, caution investors by saying that if during that one year period the taxpayer has taken actions which would only be taken if the investor was contemplating the imminent sale of the property (i.e. listing the property for sale, subdivision efforts, entering into negotiations for sale or a contract for sale), then the one year hold period would likely be considered tainted and the transaction disqualified in the event of an audit.

Read More: How long must one hold title to property to be qualified to perform a 1031 exchange?

Credit Unions Are Latest Entrants in 1031 Exchange Field

-- By Priya Jestin, Staff Writer

A credit union dabbling in 1031 exchanges? Yes if this idea has you flummoxed, guess what it did to me. I was totally out of my depth here. What have credit unions got to do with a 1031 Exchange? Well, there are some guys out there who seem to be experts on both topics and they seem pretty gung-ho about this union.

It is a fact that despite its growing importance, even today many people don’t know much about 1031 exchanges. In a 1031 exchange, you can defer, or possibly eliminate, capital gains tax if the property is exchanged for other property within a set time frame. The credit union comes into the picture as a reliable source of finance. What it can do is get the mortgage, and expand its real estate lending capacity. This in turn leads to a cycle wherein the mortgage volume expands and attracts new members. Once the business expands to a certain volume, credit unions can even join a CUSO partnership and act as intermediaries.

One of the main requirements for becoming a qualified intermediary is that you must be independent and not related to the transaction in process. Credit unions on their own cannot act as intermediaries because they don’t qualify as disinterested parties. And here’s where a CUSO comes into the picture. A CUSO can play the role of intermediary since it is not the lender, and hence not involved directly in the transaction.

And what about a credit union's liability of being seen as an advisor? Certain CUs that are already in the business use different underwriting criteria than for primary residence loans. Firstly, they ensure that the type of investors they deal in are very sophisticated and know their way around this business. Next, they try to secure two months of reserves and never go to 100% loan-to-value. Also, they try to limit such dealings to a predetermined number annually.

Debt & 1031 Exchange

How much do you know about the role debt plays in a 1031 exchange? If you are like most others, you probably believe that you are required to have debt on your new property in an amount equal to, or greater than, the debt that was paid off on your old property. Findarticles.com reports:

In fact, this is not a requirement of a 1031 exchange. The actual requirement is two fold: you must buy equal or up, and you must reinvest all of the cash.

Read more: The role of debt in a 1031 exchange

Boots & Taxes In A 1031 Exchange

-- By Priya Jestin, Staff Writer

What happens when you cannot or do not reinvest all of the cash from the sale of a property into the purchase of your exchange property? You have to pay tax. The IRS has coined a very lovely term for this part of the 1031 exchange that is taxable: Boot.

Let me use an example to explain: Imagine you sold your property for $200,000 in December 2006. You pay off your mortgage and are left with around $100,000, which you pass on to the qualified intermediary. Now you buy another property in March 2007 for $180,000, take a mortgage loan of $100,000 and pay up $80,000 in cash. This means you are still left with $20,000 in unspent proceeds. Your qualified intermediary will return this money to soon after the purchase. And you are liable to pay taxes on the proceeds or in this case, the entire $20,000.

Pass On Your Legacy, Not Taxes

--By Priya Jestin, Staff Writer

Being able to own real estate is a dream for many people. Of course you do have your 5-bedroom home, but aren’t you bogged down by mortgages and home equity loans? Well, imagine being able to really own your home/ property and then pass it on to your heirs as inheritance. So how do you pass on this inheritance without the pain of taxation?

I know you probably think I don’t know what I’m talking about. Well, how about using this strategy. Try having your real estate deeded into a family partnership or a limited liability company. Once you’ve done that, you can continue to take management income from the property. And what’s better, your heirs will receive the property without taxation. How does this happen? With a 1031 exchange of course! And your heirs can continue to 1031 exchange the property and grow a real estate portfolio.

Basically, what a 1031 exchange does is help you shelter the gain of a sale and defer all state and federal taxes. This helps you unlock the biggest impediment to a high rate of return: excess equity. So, before you pass on your real estate to your family, you need to grow it. For this all you need is to begin with a property sale and use the provisions of 1031 exchange to save the capital gains tax on your property. You can use this money for investment in a replacement property.

Once you purchase a new property as per 1031 exchange rules, you can refinance your replacement property and take out cash as loan proceeds. This means you get access to the equity in your property by refinancing it and don’t have to pay capital gains tax. All you need to remember is that before you play this game, you MUST learn the rules and never flout them.

Combine Sale, Double Benefits

--By Priya Jestin, Staff Writer

I had written recently about how homeowners can apply both IRC 121 and IRC 1031 capital gain exclusions to the sale or exchange of a home. This helps you double your savings. However, to reap these benefits, it’s very important that you qualify for and comply with all the rules in BOTH the sections. The property or portion of the property:

1 should have been used in your trade or business or been held for investment purposes within the guidelines set forth by IRC §1031

2 should have been the taxpayer’s principal residence as required under §121.

Remember, depreciation taken on a principal residence is eligible for deferral under Section 1031. You can check IRS’ web page for examples on the treatment of depreciation and boot.

Tips To A Painless 1031 Exchange

One thing that most 1031 Exchange experts always caution taxpayers is that to reap the benefits, you must play by the rules. Well, it isn’t easy to play by the rules if you don’t know them. And most guys out there, who are not into this kind of business, begin to think about 1031 exchange only when they’ve got something to sell. At this point, the rules of IRC Section 1031 may seem too complicated and too much.

But there are no easy ways out here. To get the benefits, you just have to know the rules. You simply must educate yourself on how this whole thing works. Knowing more is however not enough – it is only the first step. If you want to complete a pain free 1031 exchange, you should adhere to a few time-honored guidelines. 1031-exchange-my-story.com reports:

Discuss your plan with professionals who have experience dealing with 1031 exchanges. I can't overstate the importance of this. The section 1031 rules are tricky. Seeking guidance from professionals who routinely deal with 1031 transfers is critical. If you have done your homework, you can spend most of your time discussing the meaning of like kind property. This is the area that creates the most debate among professionals.

Read more: 5 Steps to Making a 1031 Exchange Pain Free

Does Your Property Qualify?

We all love some kind of benefits when it comes to sale and purchase of property. While a 1031 exchange is a lovely way to keep some extra cash with yourself, the property you put up for sale must fulfill the requirements laid out in IRC Section 1031. Upstatehouse.com reports:

Although IRC 1031 doesn't specify a minimum rental time, most tax advisers suggest renting a property at least six to 12 months before selling it as part of a tax-deferred IRC 1031(a)(3) "Starker exchange."

Read more: Not all property qualifies for tax-deferred exchange

1031 Exchange Drives Up Farmland Prices

It’s not only people in towns and cities that reap the benefits of 1031 exchange-related price hikes in property. A recent trend shows that the value of farmland is rising steadily. Wrex.com reports:

One factor driving up land costs is the 1031 Exchange. It's a tax incentive from the government that says if farmers make a profit from selling their land, they can trade it for land somewhere else without paying capitol gains.

Read more: Price of Farmland Goes Up; Farmers Still Find it Hard to Sell