A Tool To Help Keep Your Wealth!
The elimination of significant preferred tax treatment of capital gains has left investors only one vehicle for preserving and building their real estate wealth: The Section 1031 Tax-Deferred Exchange.

Section 1031 of the Internal Revenue Code allows investors to defer or "postpone" paying income taxes on gains from the sale of investment real property, if the proceeds are re-invested into "Like-Kind" property, in other words property used for a similar purpose such as rental properties.  You must have held the Relinquished Property the "old" property for investment or for productive use in a trade or business.

The following is a brief synopsis of the 1031 exchange:

"Like Kind" Property
Like Kind refers to the type of property being exchanged.  You can exchange any real estate investment for any other type of real estate investment -- for example, vacant land can be exchanged for rental property, a rental house for a duplex and so on.  In most cases your personal residence is not Like-Kind "investment" property.

Exchanging Up
To accomplish a fully tax-deferred exchange, the rule of thumb is...Exchange even or up in value and exchange even or up in equity.  So for instance, say you owned a duplex with $40,000 in equity, and you wanted to "trade up" to a four-plex somewhere, you would actually "exchange" the equity out of your duplex, and into the four-plex. In essence, the equity you trade into the four-plex is similar to making a $40,000 down payment only it becomes non-taxable because the profit from the sale of the duplex never actually touched your hands, it went straight from one property into the next. So you may be asking how this is accomplished? Well you must hire a "facilitator" or an attorney to handle the transaction for you. The profit from the sale of one property going into another must never touch your hands during the transaction or it becomes immediately taxable!

Boot
To the extent that you do not exchange even or up in value and exchange even or up in equity, you will have received non-qualifying property "boot" or "profit" in your exchange. If boot is received, tax is computed on the amount of gain on the sale or the amount of boot received. Needless to say, if you started out with $80,000 in equity, and you made a partial exchange, say $60,000, that would leave $20,000 left over known as "boot" and would be taxable as capital gains.

Simultaneous Exchanges
In a Simultaneous Exchange your old property is exchanged for new property at the same time in an interdependent closing.  Often, there are practical reasons why a Simultaneous Exchange cannot be structured.  Your new property may not yet be located or be ready to close before the required closing date for the old property. In such cases a successful exchange can still be completed on a deferred or "delayed" basis.

Delayed Exchanges
In a Delayed Exchange, your old property is exchanged for a promise from someone usually a facilitator company to acquire new property for you at a later date. In 1984, Congress authorized Delayed Exchanges in Section 1031 of the tax code. In 1991, the IRS issued Final Regulations on how to successfully complete a Delayed Tax-Deferred Exchange.

Time Deadlines
In a Delayed Exchange, you are required to "identify and designate" your new property on or before 45 days from the transfer of your old property; and ... Closing must occur on one or more of the properties you have identified and designated within 180 days or the closing of your tax return for the year in which the old property closed - whichever is earlier.

You can always get the full 180 days to complete your Delayed Exchange if you timely request an extension for filing your tax return.

Identification
The IRS Regulations limit your flexibility in identifying and designating new properties.  You must provide a written description either street address or legal description of your proposed new property(ies) to your facilitator no later than the 45th day.  You can identify and designate up to three properties regardless of value.

If you identify more than three properties you are limited by a value test for the identified properties. The total value of all of the properties you identify cannot exceed 200% of the old property value, boy the IRS gets you coming and going don't they?  In any event, if you understand the rules as they are drawn out, and you play it their way, you can successfully defer your profit taxes for the rest of your life, provided you keep exchanging in and out of different properties.

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