WHAT IS A 1031 TAX DEFERRED EXCHANGE

A tax deferred exchange is defined in Section 1031 of the Internal Revenue Code. By participating in an exchange, a taxpayer who owns property which has been held for investment or in connection with a trade or business can exchange the property for "like kind property" which will be held for investment or in connection with a trade or business and defer paying taxes on the capital gains. By avoiding recognition of capital gain, the taxpayer defers payment of income taxes, indefinitely. Rather than paying capital gains taxes, taxpayers have additional funds available for investment and are able to accumulate more assets and wealth.

In addition to deferring the payment of capital gains taxes, taxpayers may participate in exchanges for the following reasons:

• Diversify holdings by property type
• Acquire property in another location
• Consolidate holdings
• Move from fully depreciated property to property that can be depreciated
• Capital gains taxes may be avoided if the property is held until the property owner's death, at which point the property is valued as of the date of the decedent's death for purposes of determining its "basis"

In order to have a fully deferred exchange (rather than partially deferred), the taxpayer must meet the following three (3) criteria:

1. The fair market value of all replacement properties that are acquired should be equal to or greater than the fair market value of all relinquished properties that are transferred.
2. To the extent that there is any mortgage debt on the relinquished properties, the replacement properties should have equal or greater mortgage debt.
3. All relinquished and replacement properties should be like kind.

The IRS recommends that your tax advisor and/or attorney review and approve these documents. Our role is to provide the mechanism to accomplish the exchange. You will need to seek the counsel of your attorney and/or tax accountant for advice surrounding the details of your transaction.

EXCHANGE DEADLINES

Two very important deadlines are triggered with the closing of the first relinquished property. They are:

Identification Period - Within 45 days of the first relinquished property closing, the Exchangor must identify the replacement property(ies) which he/she wishes to identify. We will provide a Replacement Property Identification Notice to be completed with the street address or legal description of the property to be identified.

Exchange Period - All replacement property which the Exchangor wishes to acquire must be acquired by the earlier of: 1) 180 days from the date of the first relinquished property closing or 2) the due date of filing Exchangor's federal income tax return for the tax year in which the first Relinquished Property is transferred (together with all extensions).

IDENTIFICATION RULES

Identification of the replacement property must be done in writing and sent to the Intermediary by fax or mail within 45 days of the first relinquished property closing. No extension of time is provided if the 45th day is a Saturday, Sunday or legal holiday. The following rules apply to the identification of replacement property:

• 3 Property Rule - Up to 3 properties can be identified without regard to their fair market value.
• 200% Rule - If the Exchangor wishes to identify more than 3 properties, he must use the 200% rule which requires him to include the fair market value of all identified properties, add them together, and that total cannot exceed 200% of the fair market value of the relinquished property.
• 95% Exception - If the 200% rule is used and the Exchangor exceeds that amount, he will be required to close on properties totaling at least 95% of the amount identified for the exchange to qualify.

If improvements are to be constructed before the Exchangor takes title to the replacement property, they too must be specified during the identification process.

Identification may be revoked prior to the expiration of the 45 day identification period. Oral revocations are not permitted. Revocations of prior Identification Notices must be in writing and signed by the Exchangor.

Information courtesy of:  First American Exchange Company, LLC