1031 Tax Deferred Exchange - 5 Steps to Success

There are as many reasons to seek a 1031 Tax Deferred Exchange as there are investors, but the fact is that completing such a property exchange can save you a significant amount of capital gains tax when you decide to sell your existing investment property and to acquire another one. Although you should always check with your tax advisor and attorney before you proceed, here are the basic steps to successfully exchanging a property under the 1031 guidelines.Step 1 - Proper Listing Once you've determined that a 1031 exchange is in your best interests, you'll want to list your current property with a real estate broker. Make certain that the listing agreement specifically specifies that you intend to use the property to complete a 1031 exchange.Step 2 - Sales ContractOnce a buyer has been found for your property, the next step is typical of a standard real estate transaction. You'll receive an offer, which you will then accept or counter. Once both parties agree to the terms and price, you'll have an acceptance and a sale, making sure that everyone is clear about the fact that you're intending to acquire a new property under the terms of Section 1031 of the IRS code.Step 3 - FacilitatorNext, you'll open an escrow account and begin working with a facilitator. The facilitator will prepare all the documents for a 1031 exchange and will work with the escrow company during Phase One of the process. The exchange agreement must be signed by everyone involved and all earnest money must be deposited with the title company before closing the escrow.Step 4 - Find Replacement PropertyYou must then find and identify the replacement property with 45 days of closing. You'll then have 180 days to acquire and close on that property, making sure that everyone concerned knows that it's part of a 1031 exchange.Step 5 - Close on Replacement InvestmentYou'll open an escrow account on the new property, and the facilitator will begin preparing all the documents required by Phase Two of the 1031 exchange process. Your earnest money and any other funds will be held in trust by the facilitator in the escrow account until the Phase Two transaction has closed.There are other factors that can come into play during the 1031 Exchange process, so it's important that you seek the help and advice of your financial advisor and attorney to make sure you're complying with the letter of the law from start to finish. There can be significant amounts of money involved, since you're allowed to exchange your current property for several new properties, as long as their fair market value doesn't exceed 200 percent of the value of your old property.Another thing to remember is that the properties must also be of a like-kind, meaning that they will both be held for productive use in a business or investment capacity. There are also some time constraints as to when you can claim the exchange on your income taxes, so as always, it's best to check with your various professional advisors before you begin the 1031 exchange process.Copyright © 2006 Jeanette J. Fisher

Self Directed Installment Sale Vs 1031 Exchange - When a SDIS Makes Sense (Part II)

In the last article, I pointed out when, as a real estate investor, doing a 1031 Exchange on the sale of a Real Estate Property may not be your best option.

So, let's assume you do want or need to sell a real estate investment, don't want to do an exchange, and don't want to pay a huge lump sum capital gains tax payment of 15-40% on your gains. Now is the time to see how a Self Directed Installment Sale can save you money.

It's important to know that you don't avoid paying your capital gains tax obligation, you just get to spread out the obligation over many years. The total of years is typically between 10 to 30 and it is possible to defer taking payments for a while depending on your circumstances.

So, how does that help you? Well, if someone were to offer you a 0% interest loan on let's say $300,000.00 for the next 30 years, and you only had to make minimum payments, would you jump at the chance? Most people sure would. Think of how you could invest that 300K so that you could enjoy the benefit of the interest it accrued. This is effectively what a Self Directed Installment Sale does for you. It allows you to keep most of your gains working to your advantage, while paying back the money owed to the IRS over a long period of time.

This also holds for the depreciation recapture if you owned your property for a long period of time and depreciated it according to a schedule to realize annual tax advantages of owning investment real estate. This is not true for accelerated depreciation taken.

If you do not put a tax strategy in place and sell outright, not only do you owe capital gains tax, but you also owe depreciation recapture, which can be another 25-35% of your total depreciation taken over the ownership cycle of your investment.

And, you will avoid the possibility of the dreaded Alternative Minimum Tax trap. This is something else that may catch you by surprise when you least expect it triggered by your outright sale of property. This could mean having other legitimate tax deductions disqualified and a higher tax payment owed by you.

As you can see, it's definitely worth it to consult with an expert in Capital Gains Tax saving strategies before you make the decision to sell your real property.

The SDIS can also work with the sale of a second home, vacation home, business, collection, or even your primary residence. With these assets, a 1031 exchange is not an option.

"IRS Approves New Tax Deferment Program" - 1031 Exchange Without a Replacement Property?

For years, investors have taken advantage of the 1031 exchange as a method to delay or defer capital gains taxes on the sale of an investment property. By completing an exchange, the investor can sell or dispose of an appreciated investment property, use all of the equity to buy a like-kind property of equal or greater value, defer the capital gains tax and leverage all of their equity into a replacement property. The 1031 exchange is one of the last great vehicles to build wealth and save on taxes.

There still exists the investors who do not acquire a replacement property. Maybe the next move may be difficult to find the right property. The specific time-frame or an undesirable market is not conducive to executing an exchange? That investor may just want to move on with life, dispose of the asset without a replacement, but still not pay all of the capital gains upfront. Is there a solution?

There was such a solution called the private annuity trusts (PATs) which could be used to avoid capital gains taxes by transferring the title of a property to a trustee prior to the sale. Once the trustee sold the property, the proceeds from the sale would fall into the trust and then payments would be paid to the beneficiary. Most often, the trustor and beneficiary would be one and the same, therefore allowing the beneficiary (the original title holder) a method to collect payments while avoiding any upfront capital gains tax. In the fourth quarter of 2006, however, the IRS ruled that PATs were being used inappropriately to defer capital gains and estate taxes and could no longer be used in this manner.

The deferred sales trust (DST) has become the replacement strategy for the private annuity trust. Very similar to the PATs, the deferred sales trust, recognizes capital gain, but it is deferred over a predetermined period of time that is planned in advance of the sale.

Here is a breakdown of the process for a DST:
1- Private third-party company forms a trust
2- Owner sells the property to the trust
3- Trust and owner (beneficiary) put together an installment contract
4- Contract promises to pay beneficiary predetermined amount over an agreed period of time

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Example of DST vs. a Typical Sale (California)
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Assumptions:
Owned for 8 years
Purchase Price: $ 2,750,000
Sale Price: $ 4,100,000
Loan Amount: $1,750,000
Recapture Depreciation $ 800,000
Basis: $1,950,000
Taxable Gain: $2,150,000

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Standard Sale Transaction:
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Net Sale Proceeds: $ 2,350,000
Federal Tax (15%) $ 322,500
State Tax (9.3%) $ 199,950
Proceeds after tax: $ 1,827,550
Annual Interest of $ 146,204

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DST Transaction:
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Net Sale Proceeds: $ 2,350,000
Annual Interest of $ 188,000

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DST income difference of 22% or $41,796
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As you can see, the deferred sales trust can be a vehicle to defer taxes without having to acquire a new property and in the long run may actually be a more viable and lucrative choice than other tax deferment methods. To find out more information, contact a commercial real estate broker or tax professional in your area.

Exchange Your Way Out of Capital Gains Taxes - Tax Loophole Series

There is an old saying "When There is a Will, There is a Way" And many people definitely have a desire to avoid capital gain taxes when selling investment property.

Tax Loophole: When one kind of investment real estate is traded for another, the capital gains tax is fully deferred.

Generally you are not required to report a taxable gain when business or investment property is exchange for "like kind" business or investment property. The key here is the term "like kind" which refers to the characteristic of the property - NOT it's quality. Properties are of like-kind, if they are of the same nature or character, even if they differ in grade or quality.

Examples of Exchanges:

1. Exchange a rental apartment in the city for a rental home in the country.

2. Exchange a city block for farm land

3. Exchange a rental house for a commercial building.

Note: If cash is received in a tax-free exchange you may have to report and pay capital gains taxes based upon the cash received.

The possibilities and options are many. Imagine trading a rental home with a low monthly cash flow for a commercial building with a higher monthly cash flow, just because the owners want to retire?

The most common type of Exchange is known as the Forward Delayed Exchange. The Taxpayer sells investment property and will acquire a replacement property of equal or greater value within 180 days. There are stick stipulations and loads of paper work; you will need a real estate professional or attorney that specializes in 1031 Exchanges.

Take the Cash and Run - The 351 Exchange Explained

Many real estate investors have heard of the 1031 exchange, a technique where property held for investment is exchanged for "like kind" property thereby deferring capitol gains taxes until a later tax year. While investors like being able to defer taxes until a later year, many complain that they'd like a way of eliminating capital gains taxes altogether. Another major gripe of 1031'ers is that the proceeds of the transaction must be used to immediately acquire a replacement property. Failing to find a suitable property causes the entire deal to fail and leaves the investor saddled with a large tax bill. Not cool. The solution: an alternate technique, called the 351 exchange. This method allows for both, tax deferral and flexibility to use the transaction proceeds as the investor sees fit.

Here's how it works:
The 351 exchange allows the investor to defer, and maybe eliminate, the capital gains liability on the sale of real estate by exchanging title to the property for stock in a c-corporation created specifically to acquire real estate for resale purposes. No Capital gains taxes are recognized when the real estate passes to the c-corp and the c-corp pays ordinary income, not capital gains, taxes when the property is eventually sold. What's more, the proceeds from the sale do not necessarily need to be reinvested in more real estate. Unlike a 1031 exchange, the cash resulting when the c-corp eventually sells the real estate can be spent on anything that could be classified as "ordinary and necessary" for the operation of a real estate business. Cool trick huh? Lets take a look under the hood.

Here's why it works:
The property is permitted to pass from the investor free of capital gains taxes due to Section 351 of the Internal Revenue Code. It provides that "No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control [at least 80% ownership] of the corporation."

The explanation of how, and why, the c-corp can sell the property free of capital gains tax is a bit more involved. Generally, you will have a capital gain or loss if you sell or exchange a capital asset. Almost everything you own and use for personal purposes or investment is a capital asset except that property held mainly for resale is not considered a capital asset. IRS Publication 538 tells us that "Stock in trade, inventory, and other property you hold mainly for sale in your trade or business are not capital assets." The c-corp that you will use to dispose of property in a 351 exchange, was created especially for the purpose of buying real estate for resale meaning that the property is treated as inventory rather than a capital asset. A good understanding of this concept of inventory v. capital asset is key to appreciating the benefit of the 351 exchange. Here are some examples:

• Apartment bldg. rented for income- Capital Asset
• Homes owned by a builder for sale to the public- Inventory
• Merchandise held by a retailer for eventual resale- Inventory
• House owned by a flipper for rehab & resale- Capital Asset
• Office bldg. owned by a doctor to house his practice- Capital Asset

What about taxation on the sale of inventory?
I'm glad you asked. Unlike individuals who generally receive income, pay taxes, then pay expenses out of the difference; a corporation earns revenue, deducts expenses, and pays taxes on whatever is left. The name of the game is to have as little left over as possible. The c-corp has the benefit of several well known and perfectly legal methods of handling expenses that are not available to individuals or to other types of business entities. These include things like employee benefit/compensation plans (where you are the employee of course), vehicles, and health insurance, retirement plans, rental of office space plus the accompanying expenses such as utilities and supplies, and of course, to purchase more real estate (for resale), which will also be classified as inventory, not a capital asset

Aren't C-Corporations subject to double taxation?
Therein lies the rub...or so it appears. The subject of double taxation is seen by many planners and advisors as the main drawback with using the c-corp. Double taxation comes into play where after-tax earnings of a C-Corporation are distributed to shareholders as non-deductible dividends. While this is a valid concern in theory, in practice, it really should not trouble most small corporations with earnings under $5 million because of the many deductible ways to pull money out of a c-corp and avoid double taxation such as:

• Employee Compensation Plans
• Interest Payments (including loans you might make to your entity)
• Lease Payments (includes vehicles, equipment, airplanes and real estate)
• Retirement Plans (for you and your family)
• Benefit Plans (including Life and Health Insurance)
• Non-Taxable Reimbursements to you for personal funds you expended on behalf of your C-corporation.

It's not all upside though
By now you're probably saying, "What's the catch?" The catch is that the 351 exchange is not right for everyone. Many of us believe that real estate investments are long term commitments, like a marriage, as opposed to trades in the stock market which tend to be short term in nature, like taking home someone you just met at a night club (exciting but often risky and usually short-lived). If you fall into the long-term category, you're likely looking to trade-up in real estate rather than cash-out. In this case, a 1031 exchange might be more your flavor. The other issue is the cost and somewhat complex process of starting and maintaining the corporation.

While the cost and procedure of setting up a c-corp are not that onerous, there is a bit of formality. Establishing a c-corp will require the filing of certain documents with the State and complying with a few legalities. There will be attorney's fees involved in getting it off the ground as well as annual fees to maintain compliance. Because of the cost, the 351 exchange is probably better for the larger real estate investors as opposed to the guy that rents out a couple houses.

Final synopsis
In the end the 351 exchange might be a great option for investors looking to cash out and use the proceeds for something other than immediately buying another property. But don't take my word for it. All of you real estate moguls, and moguls to be, should consult with a competent real estate/tax attorney before committing to any transaction.

1031 Tax Deferred Exchange - Many Options That Each Provide Many Advantages

One aspect to choosing 1031 Tax Deferred Exchange is that you will confront numerous options from which to make up your mind and yet be sure that whichever option you choose it will help make you a considerable amount of money such as saving on paying capital gains tax at the time of selling your current investment property in order to acquire a fresh one. In fact, it would be to your advantage to, first of all, seek out professional advice before proceeding further with regard to 1031 Tax Deferred Exchange.

List With Real Estate Brokers

Having decided that 1031 Tax Deferred Exchange is what you want, you must then list with a real estate broker all of your existing properties and also ensure that such list includes an agreement that clearly states that you are using your property to complete 1031 Tax Deferred Exchange.

To be sure, if you go in for 1031 Tax Deferred Exchange, you will then be in a good position to roll-over all of the monies you receive when you sell your investment property which monies in turn must be used to purchase one or even several similar (like-kind) investment properties. However, during closing the proceeds must be transferred to a Qualified Intermediary who will keep the proceeds from the sale till such time as these proceeds are to be used to buy new like-kind property.

As mentioned, 1031 Tax Deferred Exchange permits you to also defer your capital gains tax as long as the entire amount of money from the sale of a property is used in purchasing similar (like-kind) investment properties. Thus, this deferment is tantamount to getting an interest-free loan for the entire amount that you would have spent on the cash sale which means that you get to retain more equity which in turn makes it possible for you to obtain properties with still higher values while of course, using 1031 exchange.

However, 1031 Tax Deferred Exchange is only applicable as long as you sell real estate that is investment oriented and it won't hold true if you are selling personal residential property. Also, the properties in question must be similar or more precisely like-kind which means that if you are exchanging real property then the two properties in question must both be real properties. In fact, there is also nothing stopping you from exchanging a single property for many properties or even buying a single property from the proceeds of many properties.

Unique Tax Characteristics of Exchange Traded Funds

Exchange Traded Funds (ETFs) represent a bundle of assets that look a lot like a mutual fund, only they may be traded during the day just like ordinary stocks (mutual fund units may only be redeemed at the end of the day). ETFs have gained a reputation as a low cost, tax efficient alternative to mutual funds. The only problem with this perception is that it may not be accurate. ETFs that invest in currencies or commodities can create bizarre tax ramifications to which the capital gains tax rate rules simply do not apply. This article will address the tax implications of investing in three forms of ETFs: Plain Vanilla (bundles of company stocks), Currency and Commodity ETFs.

Plain Vanilla ETF
A Plain Vanilla ETF gives the investor a tiny piece of various companies that are held in the fund. Like an Index Mutual Fund a Plain Vanilla ETF is a type of investment company which invests its funds in stocks that mirror some particular market index, such as the S&P 500 or the NASDAQ 100. Plain Vanilla ETFs can be grouped into four basic categories: Broad-Based ETFs, Fixed Income ETFs, International ETFs and Sector ETFs. Broad-Based ETFs follow specific indexes styles such as growth indexes, value indexes, small-cap, mid-cap and large- cap indexes. Fixed Income ETFs track indexes for corporate and Treasury bonds. International ETFs track indexes for foreign countries as well as international regions (i.e. Asia). Sector ETFs track indexes for specific industries such as health care.

Currency ETF
Currency ETFs aren't funds at all but, rather, trusts or limited partnerships that pass income and gains through to their investors. Accordingly, each owner of a Currency ETF takes into account his or her pro rata share of the ETF's income, gain, loss, deductions and other items for the calendar year. If you are an investor in a Currency ETF you will receive a K-1 for the year. This K-1 will itemize each specific type of income and expense passed through to you, the investor. The tax treatment of such income or gains depends on the Fund's underlying positions, so you must read the prospectus to understand the tax treatment of such income, expense, gain or loss. Currency ETFs allow you to capitalize on the strength of foreign currencies relative to the U.S. dollar. Whenever a U.S. investor buys a currency ETF, they are automatically short the dollar in the corresponding currency. This type of strategy allows you to hedge against weakness in the dollar. Currency ETFs can be taxed in eight different ways. Currency ETFs can be taxed as long-term capital gains, short-term capital gains, ordinary income, interest income, part capital gains/part ordinary income, phantom interest (interest not received) and phantom ordinary income (mark to market gains for futures contracts). Currency ETFs can create bizarre tax treatment that even your CPU would not understand.

Commodity ETFs
Like Currency ETFs, Commodity ETFs are not funds but, rather, trusts of limited partnerships that pass income and gains through to their investors. Accordingly, each owner of a Commodity ETF takes into account his or her pro rata share of the ETF's income, gain, loss, deductions and other items for the calendar year. If you are an investor in a Currency ETF you will receive a K-1 for the year. This K-1 will itemize each specific type of income and expense passed through to you, the investor. The tax treatment of such income or gains depends on the Fund's underlying positions, so you must read the prospectus to understand the tax treatment of such income, expense, gain or loss. Commodities are tangible assets used to manufacture and produce goods or services. Specific examples of basic commodity categories include agriculture, energy, livestock, metals, timber and textiles. In the agriculture segment, familiar commodities include cotton, coffee, and wheat. In the energy area, examples of commodities include natural gas and crude oil. In a Commodity ETF you are investing in a basket of commodities, which is good as it provides diversification for your commodity investment portfolio. For commodity ETFs that utilize futures contracts 60% of any gains are taxed at the long-term capital gains rate while the remaining 40% of gains are taxed as short term, which are subject to the investor's ordinary income tax rate. A commodity ETF may be subject to phantom income on mark to market gains required to be recognized by the fund. If the ETF actually holds a basket of precious metals for more than a year, such gains are subject to a 28% capital gains tax rate.

What I want you to take away from this article is to tread lightly when investing in Currency or Commodity ETFs. You must thoroughly understand what type of income the ETF investment will generate and what your tax rate will be for the various types of income generated by the ETF. With tax rising you don't want to be surprised on April 15th by the tax effects of your ETF investment.

1031 Exchange Info Guide 101

A smart tax saving tool that is gaining popularity among the real estate investors by enabling them to defer the entire capital gains tax is 1031 Exchange. Established in 1990 by the Internal Revenue Code Section 1.1031, it gives them an opportunity to defer their capital gain taxes on the sale of a property by re-investing the proceeds into "like kind" of property. However, one needs to have complete knowledge of the terms and conditions that apply for 1031 Exchange, and how it works.

Some very basic things that one should understand about 1031 Exchange are that only business and investment property qualify for the tax deferral under Section 1031. Also, the properties involved in the transactions should be of "like kind". The term "like kind' has often been misinterpreted to mean that if someone is selling an office of 1200 sq. ft. he should invest the money he gets from its sale to buy an office of 1200 sq. ft. only. However, this is not the case and this term has a very broad meaning. It actually encompasses any real estate held for productive use in a business or for investment. For personal property to qualify it must be depreciable and part of the daily operations of a trade or business, for instance automobiles, office equipment and furniture, machinery, computers, billboards, franchise licenses, and the like. 1031 Exchange does not cover cash, stock in trade or other property held primarily for sale, such as, stocks, bonds, notes or other securities or evidences of indebtedness, partnership interests, and certificates of trust or beneficial interests.

The real property to which the rules of 1031 Exchange apply includes raw land, single family homes, hotels, multi-family dwellings, factory and office buildings, shopping centers, farmland, and so on. Also, all the proceeds gained from the sale of a property should be transferred through a qualified intermediary and not by someone who is the beneficiary, so that no one can use this money for his own financial gain. To defer the capital gains tax, the proceeds should be re-invested in like kind of property, which should be of equal or greater value and equity than the exchanged property. Moreover, the time period allowed for the re-investment should be adhered to. After selling the property to be exchanged, a replacement property must be identified within 45 days and the exchange must be completed within 180 days.

Deferring all capital gains taxes is not the only benefit that one gains from 1031 Exchange. It also has some hidden benefits, such as, the provision for re-investing in another property can significantly add to one's assets. Moreover, as the property assets appreciate in value one can easily upgrade to a property of higher value with the additional cash flow. 1031 Exchange also provides the flexibility to exchange the rental properties that have appreciated in value in hot markets and re-invest into lesser-known areas that are expected to appreciate in value and become the next sizzling markets in the approaching years.

Self Directed Installment Sale Vs 1031 Exchange - When a SDIS Makes Sense (Part I)

Real Estate Investors tend to be hard core. There is nothing like having your money invested in property you can touch, visit, renovate and watch gain in appreciation.

You may have heard the term "Swap till you drop". What this term means is that as an investor,you sell your real property and exchange it for another of equal or greater value, and continue to do this until you die and leave the assets to your heirs. This does (under current tax law) allow you to avoid paying capital gains tax and recaptured depreciation forever. And, your heirs currently inherit it at the value at the date of your death. They do not pay capital gains tax and depreciation, except if they sell it over the value it was at death.

This is a good thing.

However, there is going to be a time to exit the real estate investment phase of your life. Let me give a few examples of when this might be the case.

1. You have accumulated a number of investment properties and reach a point in life you want less hands-on management responsibilities.

2. You want to slow down a bit during retirement and actually want to use some of the equity you have worked so hard to accumulate to improve your income and lifestyle.

3. The market conditions are ripe to sell, but purchasing another property of equal or greater value doesn't make sense.

4. Economic conditions warrant sale. Perhaps need for long term care for you or a member of your family.

5. Personal circumstances, such as need for additional income, debt payoff, tax consequences, property division, etc. warrant the need to sell.

6. You need to do some estate planning and need to remove some of your assets from your estate so your heirs won't have a huge estate tax obligation.

If any of these prevail, a Self Directed Installment Sale may be your best option. A SDIS will allow you to spread out your capital gains tax burden over many years, and trigger what is effectively a 0% interest long term loan from the government. How often do you get this kind of opportunity?

Part II will explain more of how a Self Directed Installment Sale can make a huge difference when any of the above circumstances might arise.

Avoid Capital Gains Tax by Using a 1031 Tax Deferred Exchange

When a real estate investor typically sells an investment property, they are taxed on any gain realized from the sale.  However through a 1031 tax deferred exchange a real estate investor can sell an investment property and buy a new property with the gain or profit from the sale and not owe taxes on the sale immediately.

Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment.  A tax deferred exchange is a method by which a real estate investor trades one or more relinquished properties for one or more replacement properties of "like-kind," while deferring the payment of federal income taxes and some state taxes on the transaction.

The IRS states specific guidelines that must be followed to qualify for the benefits of a 1031 tax deferred exchange.  The primary guideline is that the investor is not allowed to receive any material benefit from the sale of the property, must clearly identify potential replacement properties and complete the transfer within certain timeframes.

Qualified Intermediary

If the real estate investor takes control of cash or other proceeds from the sale before the exchange is complete, the exchange can be disqualified and all gain is immediately taxable.  One way to avoid premature receipt of cash or other proceeds is to use a qualified intermediary to hold these proceeds until the exchange is complete.

A qualified intermediary is an independent party who facilitates tax deferred exchanges.  The qualified intermediary cannot be the taxpayer or a disqualified person such as your lawyer or accountant or another family member.  Acting under a written agreement with the real estate investor, the qualified intermediary acquires the relinquished property and transfers it to the buyer, then they hold the sales proceeds, and finally they acquire the replacement property and transfer it to the taxpayer to complete the exchange within the appropriate time limits.

Identifying Property

The real estate investor has 45 days from the date of the sale of the relinquished property to identify potential replacement properties.  The identification of the replacement properties must be in writing and signed by the investor and delivered to the qualified intermediary.  The replacement properties must be clearly described in the written identification which usually requires a legal description and street address.

You can identify more than one property as the replacement property.  However the maximum number of replacement properties that you may identify without regard to fair market value is three properties.  You may identify any number of properties provided that the total value of these properties is not more than 200% of the value of the original property you are selling.

Time Limits

If you have correctly complied with the identification phase of the exchange, you have up to 180 days from the date of the sale of the relinquished property to complete an exchange, but the period may be shorter.  The shorter period is because you have 180 days from the sale of the relinquished property OR the due date of the investor's tax return (including extensions) for the year in which the transfer is made.  There are no extensions for this time limit.

Summary

The 1031 tax deferred exchange is a great way to maximize your wealth.  The taxes you would have paid to the government are now working to earn you money and this provides a financial leverage to greatly increase your net worth. 

This article provides a basic introduction to a 1031 tax deferred exchange and should not be relied upon as legal advice.  If you want to complete a 1031 tax deferred exchange you need to consult a competent professional.

2011 Capital Gains Tax Increase and the Impact on Business Owners

The last couple of years have been difficult for business owners and financing markets, to say the least. Limited credit, economic uncertainty among businesses and consumers, and poor financial performance across industry sectors contributed to curtailed growth prospects, and have some wondering what their long-term strategy might entail. As we head into 2010, however, there are many reasons for optimism that merger and acquisition activity will increase, including improving economic indicators, cash heavy balance sheets of strategic buyers, better than expected fund raising by private equity groups and Key Take Aways increased confidence in the private and public sectors. For potential sellers, 2010 is also an important time to consider valuation risks now versus future years due to the scheduled increase in the capital gains in 2011.

Originally signed into law in 2001, the capital gains tax rate was reduced as part of President Bush's Economic Growth and Tax Relief Reconciliation Act. Under the reduced rate, long-term capital gains and qualified dividends were taxed at 15% for the lowest two income tax brackets. The lowered rate was set to expire in 2008; however, reduced rate was extended in 2006 under Bush's Tax Reconciliation Act and is scheduled to expire at the end of 2010, at which time the rate will revert to the 2003 rates, which were 20%.

Given the capital gains tax rate increase represents a 33.33% higher effective tax rate, there is significant motivation for owners and shareholders already considering a potential sale in the near-term to consider action in 2010. Beyond avoiding a higher tax rate on long-term capital gains, sellers also need to carefully plan the timing of a potential exit in 2010 in order to secure the most attractive buyer and preserve leverage in the negotiations of the purchase agreement.

While owners and shareholders may be hesitant to pursue an acquisition without greater economic certainty, there are multiple indicators suggesting that 2010 is likely the right time to at least consider a potential a sale, given favorable terms. The capital gains tax increase serves as motivating factor; it is by no means the only one.

The following are key points for understanding the impact of the capital gains tax rate increase on M&A activity in 2010:

Consider the overall economic picture.

There are signs at the corporate level that are encouraging to mid-size firms considering being acquired. Over the last three months through January 2010, deal flow is up 16.8% over the same period a year before. Of course, last year was the one of the worst years in our economic history. However, major deals are being completed, which can cause a "bandwagon effect." In addition to corporate confidence, many private equity groups with a strong track record continue to raise money. In 2009, the average fund size raised by private equity groups was $1.5 billion, the second highest on record. This indicates more private equity groups than expected will have cash in 2010 and will need to put it to work. With a return in confidence to the markets and increasing signs of an economic stabilization, 2010 is likely to see a number of buyers enter the market with cash on hand seeking good deals.

Understand your long-term growth realities.

While the economy is expected to undergo further recovery in 2010, many mid-size firms are simply not going to be able to grow at the same rates experienced in the 2003-2008 period. Given modest growth expectations, overall business growth in the next three to five years will not be significantly higher than its current state in 2010.

It is projected that the economy will grow at an average rate of less than 3.5% for the next 3-5 year, which will mimic the growth of most industries. (There are, of course, exceptions to every rule.) Given this outlook, a company should consider a realistic growth projection as part of their calculations for keeping their business or selling it now or five years from now. This is especially so considering what will most likely be a higher capital gains tax rate in 2011 and beyond.

Think critically about timing.

Early in 2010, the market will be more favorable to sellers, who will have a range of potential buyers to choose from. Moreover, the capital gains tax rate increase puts buyers not paying all cash at a disadvantage, since the increased tax rate will apply to deferred payments at the time the payment is made. Deferred payments are likely to continue into 2011 and beyond for non-cash buyers. Therefore, sellers are more likely to find buyers with cash in hand earlier in the year.

In addition to increased choice of buyers, owners are in a better negotiating position earlier in 2010. As potential buyers know that sellers have a range of options and varying deal structures to minimize tax obligations, they are more likely to agree to terms favorable to the seller. As 2010 progresses, the buyer will be able to use the impending tax increase as leverage in deal negotiations, aware the seller has significant motivation to close before 2011. In fact, if negotiations are still ongoing in 4Q10, buyers are likely to try and discount the purchase price by 1% to 5% or seek tougher terms in the purchase agreement, knowing the seller will try and avoid paying the higher tax rate.

While not appropriate for all owners, those considering a sale in the near-term future are likely to experience favorable conditions 2010 as closing before year end avoids paying higher capital gains taxes. Additionally, early movement will prove advantageous for sellers by yielding a greater range of potential buyers and a strong position in deal negotiations. Overall, 2010 is likely to experience a significant revival in M&A activity, attracting a number of interested buyers to the market.

The 1031 Exchange Alternative - How to Sell Commercial Real Estate Without Paying Capital Gains Tax

When it comes to tax planning, eliminating the capital gains and depreciation recapture taxes on the sale of appreciated commercial real estate is a hot topic. In fact, there are countless numbers of would be sellers who don't because of this. Many would be sellers simply want out of the real estate - they're tired of landlording, fixing toilets, and never ending maintenance and management. They would like to sell, reinvest elsewhere and simply receive a check, spending their time doing what they like. Unfortunately, the only way to get out of real estate without losing control of the "asset" is to sell it outright-and pay the tax. You could implement a property exchange (1031) directed by a Qualified Intermediary, but the key word here is "exchange"- you've simply traded one for the other. You're still in real estate.

Other sellers may want to buy more real estate, but don't want the restrictions and rigid timeframes of a 1031 Exchange. What can you do? Is there any other way to get out without paying these taxes? The answer may lie in the use of a specialized trust, designed in accordance with strict IRS guidelines and a private letter ruling. It can be used as a tax deferral tool and as a 1031 Exchange alternative.

This tax deferral tool could, if implemented, save you tens of thousands of dollars in taxes that you would have otherwise voluntarily paid to Uncle Sam. These are dollars that you can use to generate a higher income and to potentially profit from. It's as if Uncle Sam let you keep the tax dollars, invest them somewhere, and use the income they generate for you. It really is like "free" money. As a result, it comes as no surprise that this strategy is gaining popularity among owners of highly appreciated commercial real estate who have properties marked for sale. With a better understanding of the process, you too can take advantage of this program.

The process begins when an owner of commercial property sells it to a special trust owned by a third party company. Then, the trust sells the property to a buyer. There are no taxes to the trust because the trust "purchased" the property from you for what it sold it for. At the completion of the sale, the money from the buyer is now in the trust. At this point, the trust begins to "pay" you. This payment isn't is a lump sum, but a payment contract, referred to as an "installment contract". This contract is similar to that of an Installment Sale, but without the restrictions and with many added benefits. This contract promises to make payments to you over a pre-specified period of time.

You can choose when and how payments are to be made. You may not need the income right away-or ever. It's up to you. The tax code requires the payment of tax to the IRS only when you begin to take installment payments. Therefore, tax is paid incrementally. It is paid in proportion to the number of years in your "installment plan". In the case of a 1031 exchange, money for a new purchase can be acquired anytime from the sale of the old property and use of this trust without paying taxes, thereby eliminating the restrictions and rigid timeframes of the 1031 Exchange. Either way, your equity is no longer "tax trapped".

This special type of trust gives you the potential to generate much more money over the long run than you would with the taxes lost in a direct sale.

This may be the most suitable or appropriate tax strategy depending on your circumstances. Contact the author for a complimentary tax analysis and to discuss your specific circumstances and goals.

The 1031 Exchange - Good For Investors, Good For The US

A 1031 tax exchange is a tactic commonly used by real estate investors so that they may defer tax liability on the sale of a property. This is done by transferring the rights to a piece of property one would like to sell to an intermediary, who holds the funds gained from the sale of the relinquished property and uses the money to acquire a replacement that fulfills the regulations set out in Section 1031 .

Although the current interest in the 1031 tax exchange could give you the impression that Section 1031 is a recent development, this is untrue. In reality, the 1031's history stretches all the way back to 1921, although the original concept was significantly different than what we today think of as an exchange. The 1031 Exchange truly came into its own in the '70s, which saw a host of significant modifications in the manner that exchanges were conducted. These modifications resulted in a more powerful conception of the exchange process and also generated increased interest from real estate investors.

The capital gains tax deferral an exchange provides to the taxpayer might, at first glance, seem to be a kind of gift from the United States government, however it is, in reality, closer to an interest free loan, because the taxpayer is expected to "repay" the extra funds gained from the capital gains tax deferral by accepting capital gains liability on the subsequent sale of a replacement property. Additionally, this "interest-free loan" is one that may be kept by the investor indefinitely; an investor can choose to make any number of 1031 exchanges before finally sell outright, at which point capital gains taxes must be paid.

The 1031 exists as a mutually beneficial arrangement between the investor and the United States government, providing a benefit for the country's economy as well as the individual taxpayer. In looking upon the transfer of money in an exchange as a continuation of an existing investment instead of as a discrete transaction liable to be taxed, taxpayers gain the opportunity to move their money to the best possible investments. This, in turn, helps to elevate the economy by bolstering job growth.

As with anything, Section 1031 has skeptics. Some advocates of change in Section 1031 will pose the argument that the tax free income gained by to the taxpayer in a 1031 creates an unfair advantage. Another common concern is that the strict time limits attached to steps in the exchange procedure could promote a frantic rate of buying, with a resultant increase in asking prices for replacement properties. The aforementioned criticisms, however, are only tenuously linked to reality, and the odds that Section 1031 will go through any noteworthy changes in the coming years are quite low. Looking at the big picture, most will agree that Section 1031 is greatly helpful to all involved, as it allows taxpayers greater profits on the sale of property while additionally encouraging job growth and therefore the greater good of the country. There is no reason to doubt that the 1031 tax exchange is destined to remain a mainstay of the investment world for years to come.

The Role of Qualified Intermediary In A 1031 Like Kind Exchange

Exchanging is a creative method for marketing property. Section 1031 of the Internal Revenue Code (IRC) offers a golden opportunity to motivated real estate buyers to defer the capital gains tax liability associated with the sale of a business or investment asset. 1031 exchanges ensure maximum return on investments to people of all financial backgrounds. However, to qualify for 1031 like kind property exchange the transaction has to be done in accordance to the detailed rules, regulations and compliance issues set forth in the tax code.

Also known as a facilitator or exchange accommodator the Qualified Intermediary serves a critical function under the Internal Revenue Code. Choosing an Intermediary to facilitate the 1031 exchange is the first and most important step. The Qualified Intermediary should be a corporation that is in the full-time business of facilitating 1031 exchanges. The Internal Revenue Code requires that the person or entity serving as QI cannot be someone with whom the exchanger has had a business or family relationship prior to the transaction. It has to be an independent organization whose only contact with the exchanger is to serve him as a QI.

A Qualified Intermediary must be used to facilitate the 1031 Exchange Transaction. By definition a 1031 Qualified Intermediary is an independent and professional facilitator who receives the funds from the original sale and holds the funds until they are needed to purchase the new exchange property. The Qualified Intermediary then directly delivers the money to the closing agent who delivers the deed directly to the real estate investor.

The QI is responsible for performing the following activities in a 1031 Property Exchange:

· Acquiring the Relinquished Property from the taxpayer

· Transferring the Relinquished Property to the buyer

· Acquiring the Replacement Property from the seller and

· Transferring the Replacement Property to the taxpayer

The QI can perform all these without ever actually taking title to either of the properties. The QI is responsible for properly filling out the appropriate tax forms for the client. A QI typically provides three different documents: the exchange agreement, an assignment, and a notice. The exchange agreement is a contract between the client and the QI that sets out the rules, which must be followed in order to complete the 1031 exchange. The assignment of the sales contract to the QI must also be in place. This is because, theoretically, the QI steps into the client's shoes and sells the property. The third document the QI provides is a notice to the party on the other side of the transaction advising that the transaction is a 1031 exchange. The purpose of notification to the other party is to prove that the exchange was in place at the closing.

An exchanger must be particularly aware of selecting a qualified intermediary before going into the transaction. There are hundreds of qualified intermediaries providing like-kind exchange services today, but most of them don't have the necessary insurance, bonding, financial backing, transactional structure, and internal controls that should be required of them. Exchange funds are often grossly under-insured, under-protected, and at risk. In today's volatile economic climate, choosing a financially solid, time-tested 1031 qualified intermediary with the necessary financial strength, resources and backing are crucial for the safe completion of a 1031 like-kind exchange transaction.