The general guidelines to follow for a taxpayer to delay all the taxable gain in a 1031 Exchange programs are as follows:
- The value of the replacement real estate must be equal to or greater than the value of the relinquished real estate.
– The equity in the replacement real estate must be equal to or greater than the equity in the relinquished real estate.
- The debt on the replacement real estate must be equal to or greater than the debt on the relinquished real estate.
- All of the net gains from the sale of the relinquished real estate must be utilized to obtain the replacement of real estate.
- There are strict timelines and identification rules that must be adhered for a 1031 exchange. First, the investor must identify the replacement real estate within 45 calendar days of the close on the relinquished real estate. This identification needs to be in writing and can obey one out of three possible identification rules.
Property Identification Rules
3-property rule: Three properties are identified irrespective of their price.
200 percent rule: Any number of properties can be identified until the time their consolidated fair market value (FMV) does not surpass 200% of the FMV of the relinquished properties.
95 percent rule:Any number of properties can be identified independently of what the aggregate FMV, provided 95% of the value of the identified properties is acquired. Also, the investor needs to close on the identified replacement property(s) within 180 days from the closing date of the relinquished property.
An independent third party should be appointed as a Qualified Intermediary (QI). The QI is expected to hold the proceeds of the sale of the relinquished property until the gains are reinvested. A written “exchange agreement” must be enacted between the investor and the QI which assists in protecting the investor from having “constructive receipt” of the exchange funds during the exchange period. QI’s ensure that rules are correctly followed and that the equity is protected. IRC rules dictate the investor to have a QI to perform a 1031 exchange.
A 1031 exchange can be a useful tool for wealth creation. However, investors must operate with their professional tax advisor to meet the requirements of IRC Section 1031, as negligence to comply with IRC Section 1031 or an unfavorable tax ruling may revoke deferral of capital gains and follow immediate tax liabilities, including tax penalties.
A Delaware Statutory Trust (DST) is an independent legal entity designed as a trust under the laws of Delaware in which each partner has a “beneficial interest” in the DST for Federal income tax purposes, and each partner is treated as owning an undivided fractional interest in the property. In 2004, the IRS issued Revenue Ruling 2004-86 which permits the use of a DST to obtain real estate in which the beneficial interests in the trust will be viewed as direct interests in replacement property for consideration of IRC 1031.
Due to DST openings being “packaged” by a 1031 sponsor with administration and funding intact, DSTs provide efficiencies in the acquisition, financing, identification, closing, and operating stages of real estate ownership.
DST properties provide a chance for diversification and low equity requirements that may allow smaller individual investors to buy in sizeable institutional investment properties. But DSTs include extra costs over the costs of direct ownership. Income created from a DST property can often be protected from tax through using depreciation and interest deductions.
1031 Exchange programs enable your money to churn the maximum profit for you. However, the exchange process is extremely complex in nature and it would be wise to seek guidance from expert professionals. We have extensive experience in handling highly profitable exchanges for our varied client base.
For consultation and assistance regarding 1031 exchange call 888-993-2835 or email us at email@example.com.