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1031 Exchange
Section 1031 of the Internal Revenue Code enables property owners who are selling 'business or investment property,' to indefinitely defer the capital gains tax relating to the sale of their property when they acquire qualifying 'like-kind' property and observe other regulations. The tax savings can be substantial for those property owners who qualify and who follow the steps prescribed by the IRS.
To consider a Section 1031 Exchange, property owners initially must meet these three qualifications:
1. The property to be sold (the 'Relinguished Property') must qualify for the IRS as a 'business or investment property.' This generally includes land, all types of residential rental property, including rented beach or resort homes, condos, single or multi-family properties, and commercial/industrial buildings; and
2. There should be a material capital gains tax liability if the Relinquished Property is sold rather than exchanged; and
3. The property owner must acquire a qualifying 'Replacement Property,' such as another rental residential property, a commercial/industrial property, or land.
Property owners who meet these three broad qualifications should look into the benefits of a Section 1031 Exchange when arranging for the sale and purchase of their properties.
Section 1031 Exchanges usually require the services of a 'Qualified Intermediary,' who will facilitate the exchange for the property owner.
FORWARD EXCHANGE GUIDELINES
1. The property owner must initiate the exchange with the Qualified Intermediary before closing on the sale of the Relinquished property. The Exchange Documents provided by the Intermediary must be signed in advance of both the sale and the purchase of any properties involved in the Exchange.
2. Both the Relinquished Property and the Replacement Property must be 'used in a trade or business or held for investment.'
3. Please note two very important deadlines:
a. unless the property owner has acquired his or her Replacement Property within 45 days of the sale of the Relinquished Property, the owner must identify potential replacement properties, in writing, to the Qualified Intermediary no later than 45 calendar days following the sale of the Relinquished Property; and
b. the Replacement Property must be purchased within the earlier of (a) 180 days of the closing of the Relinquished Property; or (b) the due date of the property owner's tax return for the year in which the Relinquished Property was sold.
4. When identifying potential Replacement Properties to the Qualified Intermediary, the property owner has these three options:
a. The Three Property Rule (most common): Any three properties regardless of their individual or aggregate market value; or
b. The 200% Rule: Any number of properties provided that their aggregate fair market value does not exceed 200% of the sale price of the Relinquished Property (or properties); or
c. The 95% Rule (not common): The value of the Replacement Properties acquired must represent at least 95% of the value of all Replacement Properties identified.
The property owner is not required to purchase all of the designated Replacement Properties, but must ultimately acquire at least one of them to complete the Section 1031 Exchange.
These are general guidelines only; there are other regulations that are not noted in this summary. For additional information on Section 1031 Exchanges, property owners are encouraged to speak with their CPA or tax advisor. Property owners are also welcome to call Beacon Exchange Company, a Qualified Intermediary company located in Boston. Beacon's toll free number is 888-525-1031.
This article was prepared by Jim Livesey of Beacon Exchange Company, 241 A Street, Suite 310, Boston, MA 02210. E-mail him at: Jlivesey@Beacon1031.com or visit their website at www.Beacon1031.com.
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