1031 Exchange Properties

Any Real Estate property owner or investor of Real Estate may now wish to consider an exchange when he/she expects to acquire a replacement property following the sale of their existing investment property.  An exchange of “like properties” enables the owner to defer or avoid all of the capital gain tax due upon the sale of the original property, currently at 15%

A 1031 Exchange, also known as a tax deferred exchange is a method for selling one property, that’s qualified, and then proceeding with an acquisition of another property (also qualified) within a specific time frame.

The process of selling a property and then buying another property is a generally considered a standardized sale and buying situation.  The “1031 exchange” is unique because the transaction is treated as an exchange and not just as a simple sale. It is this difference between “exchanging” and not simply buying and selling which, allows the taxpayer(s) to qualify for a deferred gain treatment. Basically, sales are taxable with the IRS and 1031 exchanges are not. US CODE: Title 26, §1031. Exchange of Property

The IRS code is clear that a Qualified Intermediary must be chosen and act as independent organization whose only contact with the exchanger is to serve as an intermediary for the transaction. The Internal Revenue (IRS) Code requires that the person or entity serving as (QI) cannot be someone with whom the exchanger has had a former business or family relationship prior to the transaction. A Qualified Intermediary is a neutral but essential third party that prepares the 1031 exchange documents. When selecting a QI you should make sure they are bonded and insured. Fees for this type of transaction may range anywhere from $750 – $2000 to do an exchange.  Most CPA’s and Attorney’s specializing in Real Estate or Taxes can also perform this service.

Although the 1031 exchange of the IRS code offers an excellent opportunity for Real Estate investors by means of deferred tax exchange, investors also needs to be careful as there are a number of things that if included as a part of the exchange, that can still trigger a capital gain tax bill.

The real estate property you purchase should have a mortgage debt equal to, or greater than the property you are selling. In the rare case that the real estate property you buy has a lesser mortgage debt amount than the property sold, the difference in the mortgage value will be taxable to you.

In this situation that the seller of the property refinanced the property and you happen to assume the new higher debt. You are allowed to finance it through a new loan or you can add cash to the deal and the added cash offsets the debt relief on the property sold by you.

If the seller is paying cash for any repair charges that are required by the buyer then the amount paid by the seller towards the repair charges are considered as a cash excess and would also be taxable.

Investment property and personal residence property are not considered “like kind” property. So if you are buying a four family unit as part of a 1031 exchange, and then use one of the units as your personal residence, then 1/4 of the property would be considered as a 1031 exchange excess and you will have to pay taxes on that.

Often an investment property includes appliances such as stoves, washers & dryers, refrigerators etc. If these items are included in the sale you can end up paying capital gain taxes for these appliances. Appliances are not considered “like kind” property.

There may be other situations and conditions that apply. Such as extended time frames, damaged properties or other types of “unlike kind” property criteria. Investors should always perform their due diligence and consult with their accountant and attorney to discuss both the benefits and possible tax liabilities involved.*

* The information presented in this article is meant to inform and is not intended to give legal or tax advice.