Tax Deferred Exchange Basics
KNOW THE BOTTOM LINE
Before you dig into the details, here's the bottom
line about Section 1031 like-kind exchanges: you can exchange your property
for new property and defer paying federal income tax on that exchange if
you meet the requirements of Section 1031. Your particular circumstances
will dictate the exact structure of the exchange. You should obtain good
legal and tax advice before you begin. Now, for some of the details...
PROPERTIES MUST BE "LIKE-KIND"
There are a number of requirements that must be met in order for you to complete a tax-deferred exchange successfully. For example, both the relinquished property and the replacement property must be held for "productive use in a trade or business" or "for investment." Also, the relinquished property and the replacement property must be "like-kind" to each other. The "like-kind" property qualifying rules are broad with respect to real estate. For example, raw land can be exchanged for an apartment building. However, the qualifying rules for personal property are more restrictive and focus on the use of the property.
YOU CANNOT EXCHANGE CERTAIN KINDS OF PROPERTY
Even if you hold property for investment or for use in a trade or business, certain property is specifically excluded from eligibility under Section 1031. Such property includes inventory, stocks, bonds, notes and partnership and LLC interests.
BE MINDFUL OF THE DEADLINES
There are two deadlines a taxpayer must meet to accomplish a successful exchange: the "Identification Period" deadline and the "Exchange Period" deadline. The "Identification Period" begins on the date the Exchangor transfers the relinquished property and ends at midnight of the 45th day thereafter. The Exchange Period begins on the date the Exchangor transfers the relinquished property and ends at midnight of the 180th day thereafter or the due date (including extensions) of the Exchangor's tax return. The replacement property must be acquired by the Exchangor within this 180-day window. Within the 45-day Identification Period, the Exchangor must unambiguously identify the replacement property in writing to the Intermediary. If the Exchangor wants to identify more than one replacement property, Treasury Regulations provide three separate identification rules. The most common is the "3-Property Rule" which allows an exchangor to identify up to three replacement properties without regard to fair market value of the properties. The other two are not used as often, but feel free to ask us about them.
YOU CANNOT TOUCH THE MONEY
An exchange will fail immediately if the Exchangor is in actual or constructive receipt of the relinquished property sale proceeds during the exchange. Constructive receipt occurs when the Exchangor has the unrestricted ability to request the exchange proceeds at any time during the exchange.
GET GOOD ADVICE BEFORE YOU BEGIN
Even though the rules governing tax-deferred exchanges are important and must be observed in order to complete a successful exchange, these transactions can be achieved in most instances provided you receive good advice. If you don't have your own advisor, we would be delighted to consult with you on how to structure and complete your tax-deferred exchange.