1031 Tax Exchange
1031 Exchanges and Exit Strategies
Branded for the Farmer and Rancher.
The tax deferred exchange, as defined in Section 1031 of the
Internal Revenue Code of 1986, as amended, offers investors a
great opportunity to build wealth and save taxes. By completing
an exchange, the investor (Exchanger) can dispose of their
investment property, use all of the equity to acquire
replacement investment property, defer the capital gain tax
that would ordinarily be paid and leverage all of their equity
into a replacement property. Two requirements must be met to
defer the capital gain tax:
(a) the Exchanger must acquire “like kind”
replacement property and (b) the Exchanger cannot receive cash
or other benefits (unless the Exchanger pays capital gain taxes
on this money).
In any exchange the Exchanger must enter into the exchange
transaction prior to the close of the relinquished property.
The Exchanger and the Qualified Intermediary enter into an
Exchange Agreement, which essentially requires that (a) the
Qualified Intermediary acquires the relinquished property from
the Exchanger and transfers it to the buyer by direct deed from
the Exchanger and (b) the Qualified Intermediary acquires the
replacement property from the seller and transfers it to the
Exchanger by direct deed from the seller. The cash or other
proceeds from the relinquished property are assigned to the
Qualified Intermediary and are held by the Qualified
Intermediary in a separate, secure account. The exchange funds
are used by the Qualified Intermediary to purchase the
replacement property for the Exchanger.
Important Considerations for an Exchange
· Exchanges must be completed within strict time
limits. The Exchanger has 45 days from the date the
relinquished property closes to “Identify”
potential replacement properties. This involves a written
notification to the Qualified Intermediary listing the
addresses or legal descriptions of the potential replacement
properties. The purchase of the replacement property must be
completed within 180 days after of the close of the
relinquished property. After the 45 days has passed, the
Exchanger may not change their Property Identification list and
must purchase one of the listed replacement properties or the
exchange fails!
· To avoid the payment of capital gain taxes the
Exchanger should follow three general rules:
(a) purchase a replacement property that is the same or greater
value as the relinquished property, (b) reinvest all of the
exchange equity into the replacement property and (c) obtain
the same or greater debt on the replacement property as on the
relinquished property. The Exchanger can offset the amount of
debt obtained on the replacement property by putting the
equivalent amount of additional cash into the exchange.
· The Exchanger must sell property that is held for
income or investment purposes and acquire replacement property
that will be held for income or investment purposes.
· IRC Section 1031 does not apply to exchanges of
stock in trade, inventory, property held for sale, stocks,
bonds, notes, securities, evidences of indebtedness,
certificates of trust or beneficial interests, or interests in
a partnership.
