| As an investor in real estate
you understand how important it is to preserve your wealth and your
assets. In the ever-changing world of taxation we are fortunate
to have IRC Section 1031. This tax code section allows you to exchange
from one investment property to another and defer taxes on the gain.
Thus you continue to build wealth through real estate investment,
and maintain your hard earned equity.
The exchange continues to gain popularity as one
of the last tax benefits available to investors in real estate.
IRC Section 1031 states:
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"No gain or loss shall be
recognized on the exchange of
property held for productive use in a trade or business or for
investment if such property is exchanged solely for property
of like kind which is to be held either for productive use in
a trade or business or for investment." |
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Though IRC Section 1031
was enacted as a law in 1921, the extensive exchange rules and regulations
that govern today’s transactions have largely been formulated
in the last twenty years. First American
Exchange can provide you with the
most recent information on IRS Letter Rulings and Memorandums, Court
decisions, and revisions to the Treasury Regulations to ensure that
your exchange is completed with the most current exchange information
available.
| When you select First
American Exchange as your Qualified Intermediary, we
will see that your transaction proceeds according to your plan,
and meets the legal requirements necessary for tax-deferred
treatment. Through our exchange documentation, First
American Exchange will acquire your real property (the
"relinquished property") and sell it to the purchaser.
The exchange proceeds will be held by First
American Exchange, pursuant to IRC Section 1031, which
restricts the investor from actual or constructive receipt of
the funds. Immediately, or within the maximum 180 days thereafter,
First American Exchange will
use the exchange proceeds to acquire your new property (the
"replacement property") and then transfer the property
to you. It is this “Intermediary” concept that allows
you to convert an otherwise taxable sale and purchase into a
tax deferred exchange. |
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The Delayed Exchange
The crucial elements of a 1031 Tax Deferred
Exchange can be summed up in an often-quoted phrase: “Timing
is everything”. It is critical to set up your transaction
with First American Exchange
before you transfer your relinquished property (close of escrow)
so that you will not be in actual or constructive receipt of the
exchange proceeds. Additionally, special timing requirements must
be met to qualify for tax deferral, which include:
The property you are acquiring
must be identified within 45 days of the transfer of the relinquished
property.
The acquisition of your replacement property must be completed within
180 days of the transfer of your relinquished property, or by your
tax return filing date for the year in which you transferred the
relinquished property.
| Replacement
Property Identification |
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| Identification
of replacement properties must be submitted in writing, unambiguously
described, signed by the exchanger and delivered or sent before
midnight of the 45th day. At First
American Exchange we provide
you with the forms and reminder letters to keep you in compliance
with this requirement. When identifying replacement property
you may select one of the following rules: |
Three Property Rule:
Name
a maximum of three properties, with no regard to their fair market
value.
200 Percent Rule:
Any number of properties as long as their combined
fair market value does not exceed 200% of the fair market value of
all relinquished properties.
95
Percent Rule:
Any number of properties
regardless of their combined fair market value provided 95% of the
value of the identified properties is acquired. At
First American Exchange, we will
guide you through these complex identification rules, and help you
decide which rule best suits your needs.
Like-Kind Property
To
qualify for tax deferred treatment you must acquire real property
that is “like-kind”. Like kind property refers
to real property held for productive use in a trade or business
or for investment. It does not refer to the nature, character
or type of property, but addresses the intended use of the
property. For example, you can exchange raw land for a retail
center, an office building for an apartment building, a single-family
rental for a commercial property. The interpretation of like-kind
offers great flexibility with respect to real property. |
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| Items that are not considered
like-kind to real property include (1) stock in trade or other
property held primarily for sale (2) stocks, bonds or notes
(3) other securities or evidence of indebtedness or interest
(4) interest in a partnership (5) certificates of trust or
beneficial interest, or choses in action. Additionally, foreign
property is no longer considered like-kind. |
Avoiding Boot
Boot is the term used to describe property
that is not like-kind in an exchange. Cash, personal property, notes
or reduction in mortgage (debt relief) are all examples of boot
and are subject to tax. To avoid potential boot you should acquire
property:
- Equal or greater in value
- Equal or greater in equity
- Equal or greater in debt
Since a Qualified Intermediary is prohibited from
giving tax or legal advice with regard to your particular situation,
it is important for you to consult with your tax or legal advisor
to determine if your potential exchange will generate boot and be
taxable.
| THE DOCUMENTATION FLOW OF AN EXCHANGE |
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| Relinquished Property |
Listing and offer
List your relinquished property with a licensed
real estate broker, and include 1031 exchange language. Negotiate
a purchase contract with the buyer of the relinquished property and
include 1031 exchange cooperation language.
Buyer is aware that Seller intends to perform
a 1031 Tax Deferred Exchange pursuant to Section 1031 of the Internal
Revnue Code. Buyer accordingly agrees to an assignment of this contract
by the Seller to First American Exchange
Company, a Qualified Intermediary, to successfully effectuate
the exchange. Buyer agrees to cooperate in such exchange at no cost
or liability to Buyer.
Call First American Exchange
to set up your exchange.
First American Exchange
requires:
Copy of fully executed (signed) purchase contract
Copy of preliminary title report or commitment
FAE
prepares and sends exchange documents to closing agent which include:
Closing Instructions
Exchange Agreement
Assignment of the Purchase Contract
Notice of Assignment of the Purchase Contract
Closing agent prepares documentation according
to FAE's instructions:
FAE signs as seller on instructions and closing statements
Exchanger reads and approves instructions and closing statements
Relinquished property transfer (closing)
Exchanger deeds relinquished property directly to buyer
Exchanger’s proceeds (equity) wired directly to FAE (Exchanger
cannot receive the funds)
Replacement Property
Identification and exchange period
Identify the replacement property within 45 days after the transfer
of the relinquished property. Negotiate a purchase contract with
the seller of the replacement property and include 1031 exchange
cooperation language.
Seller is aware that Buyer intends to perform
a 1031 Tax Deferred Exchange pursuant to Section 1031 of the Internal
Revenue Code. Seller accordingly agrees to an assignment of this
contract by the Buyer to First American
Exchange Company, a Qualified Intermediary, to successfully
effectuate the exchange. Seller agrees to cooperate in such exchange
at no cost or liability to Seller.
Call First American Exchange
to notify us of your acquisition.
FAE requires:
Copy of fully executed (signed) Purchase Contract
Copy of title report or commitment
FAE prepares and sends exchange documentation to closing agent which
include:
Closing Instructions
Assignment of the Purchase Contract
Notice of Assignment of the Purchase Contract
Closing agent prepares documentation according
to FAE's instructions.
FAE signs as buyer on instructions and closing statements
Exchanger reads and approves instructions and closing statements
FAE wires exchange proceeds (equity) to closing agent
Replacement property is transferred to you (exchanger) by direct
deed to complete your exchange.
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