How To Handle a 1031 Exchange Sale.
A 1031 exchange, otherwise known as a tax deferred exchange is a simple strategy and method for selling one investment property, and then proceeding with an acquisition of another investment property within a specific time frame. The logistics and process of selling a property and then buying another property are practically identical to any standardized sale and buying situation, a “1031 exchange” is unique because the entire transaction is treated as an exchange and not just as a simple sale.
It is within the Section 1031 of the Internal Revenue Code that we can find the appropriate tax code necessary for a successful exchange. We would like to point out that it is within the Like-Kind Exchange Regulations, issued by the US Department of the Treasury, that we find the specific interpretation of the IRS and the generally accepted standards of practice, rules and compliance for completing a successful qualifying transaction.
Why do a 1031 Exchange?
Any Real Estate property investor, should consider an exchange when he/she expects to acquire a replacement “like kind” property subsequent to the sale of his existing investment property. If not, the sale will necessitate the payment of a capital gain tax, which is generally around 25% depending on your income tax bracket. In addition, investor will have to pay recapture of depreciation on the property sold. Example, if you hold an investment for 15 years, the IRS depreciates it 45%. It then wants you to pay the taxes on that 45% depreciation. If combined state and federal taxes are 35% at the marginal rate, that’s about 15% of the cost of the property. If your property is fully depreciated, it becomes the whole 35% marginal tax rate.
- The total purchase price of the replacement property must be equal to, or greater than the total net sales price of the relinquished, real estate, property.
- All the equity received from the sale, of the relinquished real estate property, must be used to acquire the replacement property.
- You have 45 days to identify the replacement property.
- You have 180 days to close on your replacement property.
- Cannot do an exchange once escrow is closed.
In any case, when the replacement property purchase price is less, there will be a tax responsibility incurred. Keep in mind, you also do a partial exchanges do in fact, qualify for a partial tax-deferral treatment. This simply means that the amount, of the difference (if any), will be taxed as a Cash boot or Mortgage boot.
What we need to open an exchange for your client?
- Add an addendum to seller’s contract as noted: “Seller is doing a 1031 exchange and buyer/s must cooperate and participate at no costs to them”.
- Email a fully executed Sales & Purchase contract of your client relinquish property.
- Provide full Title company information: escrow agent, escrow number, office address, tel number etc.
- Your client full personal info: name, home address, social security#, email address, phone contact and copy of driver license.
- Timeline: As soon as you’ve opened escrow on the relinquish sale, it is a good time to contact us to start the exchange process.
Wai-Yew Lam, President
TREC Certified Instructor