4 - 1031 exchanges.ppt - 1031...•choses in action (rights to receive money or other property by...

www.ipx1031.com‐ 1 ‐

IRC §1031 Tax Deferred Exchange

1031 Exchanges

Whitney BrennanVice President

Southeast Region, IPX1031®


Today’s program is designed to help you better understand:

What is I.R.S. Code Section 1031An explanation of the basic applicability and benefits of 1031 Exchanges.

1031 Exchange Process RevealedA review of the qualifications, requirements, and restrictions pertaining to 1031 Exchanges, including time for identification, time for replacement, investment intent and holding periods, property value requirements, cash out and boot, “like‐kind” property, rules of identification, taxpayers, and selecting a Qualified Intermediary.

Tax StrategiesA review of the benefits of 1031 Exchanges including tax deferral for the taxpayer, and client development and retention for the Real Estate Professional.

Course Objectives

Objective 1

Objective 2

Objective 3


Internal Revenue Code Section 1031

“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 property of like‐kind which is to be held either for productive use in a trade or business or for investment.”

If the sale of investment property would have a capital gains tax consequence, the investor can defer the capital gains tax by reinvesting the proceeds in another investment property; in this event, the sales contract should include exchange cooperation language.

§1031 DEFERS taxes

§1031 isNOT a tax‐free transaction


• Higher Capital Gains Tax

• 3.8% Healthcare Tax

• Depreciation Recapture Tax

• State Taxes

Tax Update


Single investors exceeding the $400,000 income threshold and married couples exceeding the $450,000 income threshold now pay the new 20% capital gains tax rate.

Higher Capital Gains Tax


The Healthcare and Education Reconciliation Act added a 3.8% Medicare surtax on “net investment income.”

• Applies to individual earning over $200,000 and married couples earning over $250,000

• Net investment income includes: dividends, capital gains, retirement income and income from partnerships

3.8% Healthcare Tax


Depreciation is a way to obtain a tax deduction by spreading the cost of the real estate over period of time.

As a result, depreciation reduces the property’s adjusted cost basis.

Upon sale, the part of the gain that is related to depreciation will be taxed at the rate of 25%.

Depreciation Recapture Tax


Certain states, such as California, have a 13.3% top tax rate

• North Carolina – 5.8%• South Carolina – 7.0%• Georgia – 6.0%

State Taxes


1st CALCULATE NET ADJUSTED BASISOriginal Purchase Price (Basis) $500,000

plus Capital Improvements + $50,000

minus Depreciation ‐ $150,000

equals NET ADJUSTED BASIS $400,000

2nd CALCULATE CAPITAL GAIN*Sales Price $1,200,000

minus Net Adjusted Basis ‐ $400,000

minus Cost of Sale ‐ $80,000

equals CAPITAL GAIN $720,000

Sale vs. Exchange


3rd CALCULATE CAPITAL GAIN TAX DUERecaptured Depreciation (25%) $150,000 x 25% = $37,500

plus Federal Capital Gain (20)% $720,000 – $150,000 X 20 = + $114,000

plus Medicare Surtax (3.8%) $720,000 x 3.8%= + $27,360

plus State Tax (NC 5.8%) $720,000 x 5.8% = + $41,760

TOTAL TAX DUE $220,620

Sale vs. Exchange (cont.)


In an IRC §1031 real property exchange, you can exchange real property for any other real property in the United States or its possessions, if said property is held for productive use in a trade or business or for investment purposes.

What is Like‐Kind Property?

Retail% Interest as a TIC

Commercial

Industrial Property

Single Family

Apartments

Raw Land


With the proper intent, the following are examples of like‐kind real property exchanges:

• Residential for commercial• Commercial for industrial• Single family for multi‐family• Non‐income vacant land for income producing• Swamp land for Bank building

Like‐Kind Property (cont.)


• Stock in trade or other property held primarily for sale (i.e. property held by a developer, “flipper” or other dealer)

• Securities or other evidences of indebtedness or interest • Stocks, bonds, or notes • Certificates of trust or beneficial interests • Interests in a partnership • Choses in action (rights to receive money or other property by judicial

proceeding) • Foreign property (real or personal) for U.S. based property • Goodwill of one business for goodwill of another business

IRC §1031 does not apply to any exchange of:

Like‐Kind Property (cont.)


In order to obtain a deferral of the entire capital gain tax the Exchanger must:

1. Purchase property of EQUAL OR GREATER value. 2. Reinvest ALL of the net proceeds from the relinquished property.3. Obtain EQUAL OR GREATER financing on the replacement property

than was paid off on the relinquished property. Replacement property debt can be offset with cash put into the exchange.

4. Receive nothing in the exchange but like‐kind property.

To the extent the Exchanger fails to observe these rules they will be subject to capital gain tax.

Basic 1031 Rules


For 100% deferral

Thumbnail Test

in value

debt

Spend ALL net proceeds


Any non like‐kind property received in an exchange• Cash, installment note, debt relief or personal property

Partially tax deferred exchange is valid• Where exchanger receives like‐kind property and boot

What is Boot?


RelinquishedValue $1,000,000

‐ Debt $300,000

‐ Cost of Sale $60,000

Net Proceeds $640,000

For full tax deferral, a Taxpayer must meet two requirements:

1. Reinvest all net exchange proceeds2. Acquire property with the same or greater debt.

Boot: Run The Numbers


Relinquished Replacement BootValue $1,000,000 $1,300,000

‐ Debt $300,000 $660,000 $ 0


Net Proceeds $640,000 $640,000 $ 0


The Taxpayer acquired property of greater value, reinvesting all net proceeds and increasing the debt on the replacement property.

Analysis: There is no boot.


Relinquished Replacement BootValue $1,000,000 $800,000

‐ Debt $300,000 $260,000 $ 40,000


Net Proceeds $640,000 $540,000 $ 100,000

Total Boot $ 140,000


The Taxpayer acquired property of a lower value, keeps $100,000 of the net proceeds and acquired a replacement property with $40,000 less debt.

Analysis: This results in a total of $140,000 in boot. ($40,000 mortgage boot and $100,000 in cash boot = $140,000)


The Exchange Process


1. 45‐Day RuleThe Exchanger must identify the potential replacement property or properties within the first 45 days of the 180 day Exchange period.

2. 180‐Day RuleThe Exchanger must acquire the replacement property or properties within 180 days, or the date the Exchanger must file a tax return (including extensions) for the year of the transfer of the relinquished property, whichever occurs first.

3. There are no extensions for Saturdays, Sundays, or holidays.4. The time limits begin to run on the date the Exchanger transfers the

relinquished property to the buyer.5. The “date of transfer” will be the date of recording or transfer of the benefits

and burdens of ownership, whichever occurs first.

Delayed Exchange Time Limits


1. Three Property RuleThe Exchanger may identify up to three properties of any value.

2. 200% RuleThe Exchanger may identify more than three properties if the total fair market value of what is identified does not exceed 200% of the fair market value of the relinquished property.

3. 95% ExceptionIf the Exchanger identifies properties in excess of both Rule 1 and Rule 2, then the Exchanger must acquire 95% of the value of all properties identified.

Exchange Identification Rules


1. The property identification must be delivered to a party to the exchange that is not a disqualified party (e.g., the Qualified Intermediary).

2. It must be in writing and signed by the Exchanger.3. It must be “unambiguous” (site specific). 4. It must be delivered, mailed, faxed, or “otherwise sent” within the 45

days.5. An identification can be revoked within the 45 days, but the revocation

must also follow steps 1 through 4.

Procedures for Property Identification


To qualify as a Safe Harbor against actual or constructive receipt of the exchange funds, the Exchange Agreement must limit the Exchanger’s right to receive, pledge, borrow, or otherwise receive the benefit of money or other property except:

1. After the end of the 45‐day Identification Period, if Exchanger has not identified any replacement property;

OR2. If Exchanger has identified replacement property; then upon or after receipt by

Exchanger of all replacement property to which Exchanger is entitled under the Exchange Agreement;

OR

3. If Exchanger has identified replacement property; then upon or after the occurrence, after the end of the Identification Period, of a material and substantial contingency that: (a) relates to the exchange, (b) is provided for in writing and (c) is beyond the control of Exchanger and of any disqualified party, other than the party obligated to transfer replacement property to Exchanger;

OR4. After the end of the 180‐day Exchange Period.

Safe Harbor Restrictions

4 - 1031 exchanges.ppt - 1031...•choses in action (rights to receive money or other property by...

Documents