1031 Tax Deferred Exchanges: What You Need To Know

An interview with Matthew Scheriff, CPA

PATCH:  Matt, what’s a 1031 exchange?

MS:  A 1031 exchange allows an investor to defer the capital gains tax on the sale of business or investment property. Basically, instead of paying the tax owed, you take that money and buy more investment property.

PATCH:  So, then is the exchange a tax free transaction?

MS:  No, it’s a deferral of tax. The tax liability carries forward to the new property. The good news is you are getting the use of those funds (that would have otherwise been used to pay the tax). It’s an interest free loan from the government.

PATCH:  Do I have to buy a property of similar use or type?

MS:  The tax code requires that you buy new property to be used for business or investment purposes. For example, you can sell a residential rental property and replace it with an office building, shopping center, industrial property, etc. anywhere in the United States.

PATCH:  What qualifies as an “investment property?”

MS:  Generally a property should be held for its income producing ability or the appreciation opportunity to qualify. Furthermore, the longer an investor holds a property will help further demonstrate the investment intent. Investors who hold their relinquished property for two years generally satisfy the requisite intent for a 1031 exchange, however, one year has generally been accepted.

VACATION AND SECOND HOMES

PATCH:  Perhaps our readers would like to know if a vacation or second home qualifies for a 1031 exchange?

MS:  Generally speaking, if the property is utilized primarily for the personal use of the investor and their family, the property will not qualify. 1031 exchanges apply to investment property and therefore the property really must be more of a “rental” property to qualify for tax deferral treatment.

DELAYED EXCHANGE TIME LIMITS

PATCH:  What are the time limitations associated with a 1031 exchange?

MS:  There are two key dates in a 1031 exchange – 45 days & 180 days. The exchanger has 45 days from the date of the sale of the first property to identify potential replacement property and, generally, 180 days from the date of the sale of the first property to complete the acquisition of the replacement properties.

IDENTIFICATION RULES

PATCH:  How many properties can the taxpayer identify?

MS:  In most cases the exchanger will identify up to three properties regardless of value (the Three Property rule).

RULES TO OBTAIN A COMPLETE DEFERRAL

PATCH:  Do I have to acquire a property of equal or greater value to the net sale price of the relinquished property?

MS:  Yes, in order to completely defer the applicable capital gains tax. To the extent you purchase a property of lesser value, you will be taxed on the difference.

PATCH:  Do I have to use all the cash proceeds from my sale toward my purchase?

MS:  Yes, you must use all cash proceeds from the transaction in order to completely defer the applicable capital gains tax. To the extent you do not use all your proceeds on the purchase, you will taxed on the difference.

PATCH:  May an individual, corporation or partnership be involved in a 1031 exchange?

MS:  Yes, provided the entity selling the relinquished property is the same as the entity purchasing the replacement property.

PATCH:  How do I start a 1031 exchange?

MS:  You must contact a Qualified Intermediary before you sell your property, so that you can complete the appropriate documentation and structure the exchange. Your attorney or CPA can not act as the intermediary as you must use an independent party.

There are further rules governing a 1031 Tax Deferred Exchange, too numerous to mention in this article. If you would like more information about 1031 exchanges, please contact Matthew Scheriff.

Matthew K. Scheriff, CPA (877) 628-1031; Matt@legal1031.com; www.legal1031.com

FOR LEASE - NEW CANAAN

OFFICE

Address                  Sq. Ft.          Cost                    Notes

50 Locust Ave.        700 SF         $28.00 per/sf      Parking Level*

50 Locust Ave.        780 SF         $28.00 per/sf      1st Floor - Space A*

50 Locust Ave.        1,400 SF      $28.00 per/sf      1st Floor - Space B*

50 Locust Ave.        4,398 SF      $28.00 per/sf      2nd  Floor*

*Sublease.

Information obtained from Loopnet.