1031 Tax Exchange Information

To start a 1031 Exchange, you first check with their CPA or accountant. You and your CPA need to figure out how much you would have to pay in taxes if you just sold the property outright. Your CPA can determine your adjusted basis in your property. Once your basis is known, you can then determine what the "normal" capital gain tax liability would be; and, also the amount of taxes that would be due to "depreciation recapture", which is currently taxed at maximum rate of 25%. Note: The rate of capital gains taxes is higher for the portion of the gain that is attributable to depreciation.

Likewise, your CPA or accountant will determine how much of the gain relates to normal appreciation from the natural increase in the value of the property. This appreciation is currently taxed at a maximum rate of only 15%. Your CPA will also determine if any state income tax or capital gains tax would be incurred. This would also include municipal tax liability.

After determining all of the tax liability from selling your property, you can decide to sell it outright or to sell it utilizing the tax advantages of a 1031 Exchange. Knowing all of the tax liability helps you to make a clear decision. Normally, the 1031 Exchange will result in a far less tax bill than if you sold the property outright.

After your potential taxes are determined, you should call a Qualified Intermediary, and inform them (the QI) of your wish to complete a 1031 Exchange. Typically, you also need a written Purchase Agreement, signed by both you as the seller, and your purchaser, stipulating your desire to sell your relinquished property as part of a 1031.

In addition, it is a good idea to add a stipulation or clause in the purchase agreement stating that you want to complete a 1031 Exchange with regards to the property and that the purchaser agrees to cooperate with such. You have now laid the basic groundwork for the closing. For sample cooperation clause go to www.1031podcast.com.

At the closing, the sale will become complete. The deed crosses the desk to the purchaser, and the net sales proceeds are paid directly to the Qualified Intermediary. This starts the 1031 countdown. The day after the closing is considered "day one" in the forty-five day identification period. During the forty-five days, you must identify in writing the property that you want to purchase as your replacement property. This "day one" is also the start of the 180 day exchange period that you have to complete the 1031 exchange and acquire your replacement property.

Now, I will review the steps you need to make in order to complete a 1031 Exchange transaction. The first step is to determine the capital gains tax bill, including depreciation recapture and state and local taxes. This step would be performed by your CPA or accountant. The next step is to determine if the 1031 Exchange process would be of benefit to you. This step would be made by your CPA or accountant with the help of a 1031 Exchange Qualified Intermediary. In step three, you should document your intent to sell the property to the purchaser, as well as your desire to complete a 1031 Exchange by inserting appropriate text in your purchase agreement.

If you have all of these things done, you can start the processes of deferring taxes and keeping your money working for you.

U.S. investors can save big money by utilizing a 1031 exchange to defer all of their capital gains tax on the sale of investment property. A 1031 tax exchange is like an interest free loan from Uncle Sam.

The basic premise behind a 1031 exchange is that that you, the taxpayer, are shifting all of your equity from one property to the next. In effect, the old debt is being offset by the new debt on the replacement property. However, there are two ways to usurp this premise and cash out some of your equity: pre-exchange refinancing, and post-exchange refinancing. Pre-exchange financing will be discussed first.

In a 1031 exchange, all the proceeds from the sale are supposed to be passed on to the Qualified Intermediary - this prevents you from receiving any cash benefit from the sale. There may be times, however, when you would like to use some of that money for other purposes. If you decide to refinance your property shortly before the 1031 exchange and use that equity for your desired luxury item, you may find yourself violating IRS rules. (IRS vs. Garcia)

In IRS vs. Garcia, it was decided that Garcia when refinancing his property in anticipation of the 1031 exchange, should have paid taxes on the money not used on the new property. Garcia tried to avoid the tax and ran afoul of the 1031 rationale and the IRS.

The other way of recovering funds via refinancing is the Post 1031 Exchange Finance on the replacement property. This is a good way for you to take some of that equity out of the replacement property and buy more real estate. There is a question, however, on how long you have to wait before the refinancing after the 1031 Exchange is completed.

The nanosecond refinance is waiting just long enough after the 1031 to show the IRS, through the closing statement, that you’ve re-invested all of your equity into the replacement property. In a separate transaction, a new settlement statement is used to show that the replacement property was encumbered with new debt via a loan or mortgage, then there is a cash payment from the lender to you. Thus, there is a pool of money you can access after the exchange.

The legality of the nanosecond exchange is debatable. There are risks because there is no definitive IRS rule regarding how long you are to keep the equity in the replacement property. A more prudent approach would be to keep the money in the replacement property in order to avoid the Garcia trap. In this case, keep the equity in the replacement property until the following tax year or until two years have passed from the 1031 exchange to the ultimate finance.

United States investors can save a lot of money by utilizing 1031 exchange to defer all of their capital gains tax on the sale of investment property. A 1031 tax exchange is similar to an interest free loan from the U.S. Government.