A commonly used term in investment real estate is the “1031 exchange.” This Internal Revenue Code allows investors to defer capital gain taxes when disposing of investment properties, and it is revolutionizing real estate investment.
The IRC 1031 states:
“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 the property of like-kind which is to be held either for productive use in a trade or business or for investment.”
The definition of “like-kind” within this code is actually quite flexible. Investors can relinquish any investment property including commercial, raw land, multifamily, single family, etc., and exchange it for replacement properties in any or all of these categories. Any real property held for investment or real property used in a trade or business can be exchanged for any other real property held for investment or real property used in a trade or business.
Though there are actually five kinds of exchanges, the most common is the Delayed Exchange. Before closing escrow on a property, the investor should speak with their Qualified Intermediary to receive advice and direction. Once the relinquished property has closed escrow, the investor has 45 calendar days to nominate, and a total of 180 calendar days (from close of escrow of the relinquished property) to acquire and close a “like-kind” property.
When identifying replacement properties, there are three rules of identification:
- Three Property Rule – The exchanger may identify a maximum of three replacement properties, without regard to the fair market value of the properties. This is the most common rule used by most investors.
- Two-Hundred Percent Rule – The exchanger may identify any number of properties as long as the total fair market value does not exceed 200% of the total fair market value of the relinquished property.
- Ninety-Five Percent Exception – The exchanger may identify any number of properties without regard to the combined fair market value as long as the properties acquired amount to at least 95% of the fair market value of all identified properties.
In any situation, while using any rule, in order to fully defer all capital gain taxes, an exchanger must meet two requirements:
- Reinvest All Exchange Proceeds – Any exchange proceeds not re-invested is considered “cash boot” and is subject to capital gain taxes.
- Acquire Property with Same or Greater Debt – Any reduction in debt is considered a benefit to the exchanger, and is therefore taxable.
*ROI Group encourages all clients considering a 1031 tax deferred exchange to consult legal and tax advice regarding their specific situation. Also, ROI Group encourages investors to identify and consult a Qualified Intermediary before considering an exchange. There are many excellent companies in the market, and several of the largest and most well-respected include:
www.apiexchange.com Asset Preservation Incorporated
www.ipx1031.com IPX 1031, Investment Property Exchange Services
www.starker.com Starker Services, Inc.
The ROI Group is a licensed group affiliated with Keller Williams Integrity First
