Many Montana investors have reaped the benefits of exchanging like properties using a 1031 tax-deferred exchange. There are many benefits associated with a 1031 Exchange.
An IRC 1031 Tax-Deferred Exchange represents a legal, strategic method for acquiring or selling qualified properties in exchange for “Like-Kind” properties within a specific time frame to defer capital gains taxes. You may be able to save substantial dollars by “Exchanging” property.
A list of a few of the possible benefits:
- Taxpayers can keep the “Earning Power” of the tax dollars working for them in another investment
- Since no taxes are paid on an exchange, money can be considered an “interest-free loan” from the IRS
- Tax liability is forgiven upon the death of the taxpayer, which means that the taxpayer’s estate never has to repay the “loan”
- Equities from several properties can be consolidated into a single, more efficient property
- Management-intense properties can be sold and replaced with more manageable properties
- Property owners who move to a new geographic location can relocate their equities
For a transaction to qualify for tax-deferred treatment under Section 1031, certain requirements must be met:
The property must be “like-kind”:
Replacement property acquired in an exchange must be like-kind to the property being relinquished. The words “like-kind” refer to the nature or character of the property and not to its grade or quality. In an exchange “like-kind” only applies to real property that has been used for business, trade, or investment purposes. There is some flexibility in this definition. Although the properties involved in an exchange must be like-kind, they do not need to be exactly alike.
Below is a list of properties that can all be exchanged with one another:
- Single-Family Rentals
- Industrial Buildings
- Golf Courses
- Retail Space
- Farms and Ranches
- Hotels and Motels
- Leases with 30 years +
- Multi-Family Rentals
MINIMUM REINVESTMENT REQUIREMENTS:
Real property that is sold must be replaced with real property. Also, as a rule of thumb, the value of what is bought must be equal to or greater than the value of what is sold, less closing costs. In sum, all proceeds from the sale of the relinquished property must be re-invested into the new property rather than sold for cash. If any proceeds are left over or used for other purposes they are considered a gain and are subject to taxation. If this is the case, the transaction is a partial tax-deferred exchange.
In general, IRC section 1031 provides that you must exchange for “like-kind” property. You must acquire a property with loans, equity, and sales price which are equal to or greater than the property exchanged.
EXCHANGE PROPERTY IDENTIFICATION RULES:
Three basic rules serve to limit the number of properties that can be identified. The Taxpayer shall identify only that number of Replacement Properties which meets one of the “rules” set forth below:
- The Three-Property Rule – Three (3) Replacement Properties without regard to the fair market value of the Properties. For those who identify more than three properties, the next two rules apply.
- The 200% Rule – Any number of Properties, so long as their aggregate fair market value as of the end of the Identification Period does not exceed two hundred percent (200%) of the aggregate fair market value of the Relinquished Property, as of the date the Relinquished Property was transferred by the Taxpayer.
- The 95% Rule – Any number of Properties without regard to their aggregate fair market value, so long as the Taxpayer received identified Replacement Properties constituting at least ninety-five percent (95%) of the aggregate fair market value of all identified Replacement Properties before the end of the Exchange Period.
A SPECIFIC HOLDING PERIOD MUST BE MET:
The general rule is that a taxpayer must hold the property for at least two years before it can be considered for tax-deferred treatment. This rule applies both to the relinquished and replacement properties.
There is a more strict time requirement when related parties are involved: when selling to a related party, the related party must hold the relinquished property for at least two years. Selling the property prior to the two-year mark will disallow the exchange.
YOU MUST USE A QUALIFIED INTERMEDIARY:
As stated by the IRS, “a Qualified Intermediary must be used in every exchange, even if the Taxpayer has identified a replacement property prior to selling the old property.”
The Qualified Intermediary acts as the non-biased third party during an exchange transaction. The intermediary holds all funds and prepares any documentation pertinent to the exchange. If at any time the IRS feels that the Taxpayer has been in direct contact with the proceeds from the sale of the relinquished property, the exchange will be disallowed. For this reason, it is extremely important that a trusted Qualified Intermediary be used.
During an exchange, the Qualified Intermediary could possibly be dealing with millions of dollars. It is crucial that an investor chooses a company that is financially sound.
To learn more about how a 1031 tax-deferred exchange can work for you and your investment strategy, please click on the link to NCS Exchange Professionals, a Qualified Intermediary for 1031 Tax Exchanges. NCS has handled a multitude of exchanges and provides an excellent and informative website to assist you with this process: What is Exchange?.