What Is A Deferred 1031 Tax Exchange

What is​ a​ Deferred 1031 Tax Exchange?
A tax deferred exchange represents a​ simple,​ strategic method for selling one qualifying property and the​ subsequent acquisition of​ another qualifying property within a​ specific time frame.
Although the​ logistics of​ selling one property and buying another are virtually identical to​ any standard sale and purchase scenario,​ an​ exchange is​ different because the​ entire transaction is​ memorialized as​ an​ exchange and not a​ sale .​
And it​ is​ this distinction between exchanging and not simply selling and buying which ultimately allows the​ taxpayer to​ qualify for deferred gain treatment .​
So essentially,​ sales are taxable and exchanges are not.
Internal Revenue Code,​ Section 1031
Because exchanging represents an​ IRS-recognized approach to​ the​ deferral of​ capital gain taxes,​ it​ is​ important for us to​ appreciate the​ components and intent underlying such a​ tax deferred or​ tax free transaction .​
It is​ within Section 1031 of​ the​ Internal Revenue Code that we find the​ core essentials necessary for a​ successful exchange .​
Additionally,​ it​ is​ within the​ Like-Kind Exchange Regulations,​ previously issued by the​ Department of​ the​ Treasury,​ that we find the​ specific interpretation of​ the​ IRS and the​ generally accepted standards and rules for completing a​ qualifying transaction .​
Throughout the​ remainder of​ this booklet we will be identifying these rules and requirements,​ although it​ is​ important to​ note that the​ Regulations are not the​ law .​
They simply reflect the​ interpretation of​ the​ law (Section 1031) by the​ Internal Revenue Service.
Why exchange?
Any property owner or​ investor who expects to​ acquire replacement property subsequent to​ the​ sale of​ his existing property should consider an​ exchange .​
To do otherwise would necessitate the​ payment of​ capital gain taxes in​ amounts which can exceed 20-30%,​ depending on​ the​ appropriate combined federal and state tax rates .​
In other words,​ when purchasing replacement property without the​ benefit of​ an​ exchange,​ your buying power is​ dramatically reduced and represents only 70-80% of​ what it​ did previously.
Basic exchange rules
Let us look at​ a​ basic concept,​ which applies to​ all exchanges .​
Utilize this concept to​ fully defer the​ capital gain taxes realized from the​ sale of​ a​ relinquished property:
1 .​
The purchase price of​ the​ replacement property must be equal to​ or​ greater than the​ net sales price of​ the​ relinquished property,​ and
2 .​
All equity received from the​ sale of​ the​ relinquished property must be used to​ acquire the​ replacement property.
To the​ extent that either of​ these rules is​ abridged,​ a​ tax liability will accrue to​ the​ Exchangor .​
If the​ replacement property purchase price is​ less,​ there will be tax .​
To the​ extent that not all equity is​ moved from the​ relinquished to​ the​ replacement property,​ there will be tax .​
This is​ not to​ say that the​ exchange will not qualify for these reasons; partial exchanges do in​ fact qualify for partial tax deferral .​
It simply means that the​ amount of​ any discrepancy will be taxed as​ boot,​ or​ non-like-kind,​ property.
Four common exchange misconceptions:
1 .​
All exchanges must involve swapping or​ trading with other property owners .​
Before delayed exchanges were codified in​ 1984,​ all simultaneous exchange transactions required the​ actual swapping of​ deeds and simultaneous closing among all parties to​ an​ exchange .​
Often times these exchanges were comprised of​ dozens of​ exchanging parties as​ well as​ numerous exchange properties .​
But today,​ there is​ no such requirement to​ swap your property with someone else in​ order to​ complete an​ exchange .​
The rules have been streamlined to​ the​ extent that the​ current process is​ reflective more of​ your qualifying intent rather than the​ logistics of​ the​ property closings.
2 .​
All exchanges must close simultaneously .​
Although there was a​ time when all exchanges had to​ be closed on​ a​ simultaneous basis,​ they are rarely completed in​ this format any longer .​
In fact,​ a​ significant majority of​ exchanges are now closed as​ delayed exchanges.
3 .​
Like-kind means purchasing the​ same type of​ property which was sold .​
The definition of​ like-kind has often been misinterpreted to​ mean the​ requirement of​ the​ acquisition of​ property to​ be utilized in​ the​ same form as​ the​ exchange property .​
In other words,​ apartments for apartments,​ hotels for hotels,​ farms for farms,​ etc .​
However,​ the​ true definition is​ again reflective more of​ intent than use .​
Accordingly,​ there are currently two types of​ property that qualify as​ like-kind:
- Property held for investment,​ and/or
- Property held for a​ productive use in​ a​ trade or​ business.
4 .​
Exchanges must be limited to​ one exchange and one replacement property .​
This is​ another exchanging myth .​
There are no provisions within either the​ Internal Revenue Code or​ the​ Treasury Regulations that restrict the​ amount of​ properties that can be involved in​ an​ exchange .​
Therefore,​ exchanging out of​ several properties into one replacement property or​ vice versa,​ relinquishing (selling) one property and acquiring several,​ are perfectly acceptable strategies.
What Is A Deferred 1031 Tax Exchange What Is A Deferred 1031 Tax Exchange Reviewed by Henda Yesti on July 06, 2018 Rating: 5

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