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Section 1031
of the U.S. Internal Revenue Code allows investors to defer
capital gains taxes on exchanges of like-kind properties. For
real estate exchanges, like-kind replacement property means any
improved or unimproved real estate held for income, investment or
business use. One property can be exchanged for two or more
properties, two or more properties can be exchanged for one
property, a duplex can be exchanged for a four-plex, etc.
Many baby
boomers are using one or more investment properties to
purchase their future retirement home. By purchasing their “dream
home” in advance, these soon-to-be-retirees will rent out the
property until retirement. Then later they are able to sell their
existing personal residence without a capital gains penalty (subject
to IRS maximum guidelines) and subsequently move into the “rental”
which now becomes their new personal residence. Using a 1031
Exchange has allowed them eliminate capital gains tax entirely on
their original investment property as well as their original
personal residence.
A Qualified
Accomodator or Intermediary takes temporary title to the
properties until after the exchange has been completed. The taxpayer
cannot ever be in possession of the funds received from the sale of
the relinquished property. The replacement property title must be
taken in the same name as the relinquished property was titled.
A Deferred
Exchange is an exchange where the replacement property is
closed on at a later date than the closing of the property that is
being sold. There are strict time frames established for completion
of a deferred exchange. The replacement property must be identified
within 45 days of closing on the relinquished property, and closed
on within 180 days of the sale date of the first property.
A Reverse
Exchange is an exchange in which the replacement property is
purchased and closed on
before the relinquished property is sold. Usually the
Accomodator takes title to the replacement property and holds title
until the taxpayer can find a buyer for his relinquished property
and closes on the sale. The reverse exchange is subject to the same
general time frames as a deferred exchange, with 45 days from the
purchase of the replacement property to identify the property to be
relinquished and 180 days to close on the sale and complete the
exchange.
Exchanges are
normally for purchases of property of equal or greater value
than the one being relinquished to avoid capital gains taxes
entirely, but occasionally the seller may wish to keep part of the
proceeds. In this case the seller may be taxed on only the portion
of the Exchange that is in excess of the property being purchased.
Always make
sure to consult your tax accountant to determine the true
benefits and tax implications a 1031 Exchange may have for you
personally.
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