“1031 Exchange Explained”
By James Nsien2
http://james-nsien2.com
A 1031 exchange, otherwise known as a tax deferred exchange is a simple strategy and method for selling one property, that’s qualified, and then proceeding with an acquisition of another property within a specific time frame. It’s a way for owners of business and investment Real Estate to sell their property and buy other like kind property without paying the Capital Gains Tax. This and allows the investor to continue his investment in another property without loosing investment equity to taxes.
Trading or exchanging property has gone on for many years but there were no clear IRS rules on how those transactions would be taxed. That all changed in the summer of 1990 when the I.R.S. finally came out with the long awaited rules on Deferred Exchanges. Section 1.1031 of the Internal Revenue Code laid out in detail the procedure for turning a sale and purchase type transaction into an exchange.
The logistics and process of selling a property and then buying another property are practically identical to any standardized sale and buying situation, a “1031 exchange” is unique because the entire 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, in the end, allows the taxpayer(s) to qualify for a deferred gain treatment.
After you have signed your purchase & sale contract, and made arrangements with title/escrow company or attorney to close your transaction, it’s time to set up your 1031 exchange. Due to the fact that exchanging, a property, represents an IRS-recognized approach to the deferral of capital gain taxes, it is very important for you to understand the components involved and the actual intent underlying such a tax deferred transaction. It is within the Section 1031 of the Internal Revenue Code that we can find the appropriate tax code necessary for a successful exchange.
Any Real Estate property owner or investor of Real Estate, should consider an exchange when he/she expects to acquire a replacement “like kind” property subsequent to the sale of his existing investment property. Anything otherwise would necessitate the payment of a capital gain tax, which can exceed 20-30%, depending on the federal and state tax rates of your given state. To make it easy to understand, when purchasing a replacement property (without the benefit of a 1031 exchange) your buying power is reduced to the point, that it only represents 70-80% of what it did previously (before the exchange and payment of taxes). Below is a look at the basic concept, which can apply to all 1031 exchanges. From the sale of a relinquished real estate property, we should understand this concept so that we can completely defer the realized capital gain taxes.
The two major rules to follow are:
1. The total purchase price of the replacement “like kind” property must be equal to, or greater than the total net sales price of the relinquished, real estate, property.
2. All the equity received from the sale, of the relinquished real estate property, must be used to acquire the replacement, “like kind” property.
The extent that either of these rules (above) are violated will determine the tax liability accrued to the person executing the Exchange. In any case which the replacement property purchase price is less, there will be a tax responsibility incurred. 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 (1031) exchange will not qualify for these reasons. Keep in mind, partial exchanges do in fact, qualify for a partial tax-deferral treatment. This simply means that the amount, of the difference (if any), will be taxed as a boot or “non-like-kind” real estate property.
James Nsien2
NCN Real Estate Investments, LLC
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