Courtlandt Financial Group

Section 1031 Exchange Overview

A Section 1031 Exchange allows an investor the opportunity to reinvest the funds from an investment property sale into replacement properties without facing immediate capital gains taxes on the appreciated value of the relinquished property. With Internal Revenue Code Section 1031 exchange replacement properties, the taxes will be deferred until the sale of the replacement property. Deferrals can be continued through as many exchanges as the investor wishes, with the tax liability passing into that investor's estate in the event of their death. Section 1031 Requirements

1031 replacement properties must be considered "like kind" (similar in character or nature, notwithstanding differences in quality or grade) in order to qualify for tax deferral. To qualify as like-kind, the investor must hold them for productive use in a business or for the purpose of investment. Types of like-kind properties may include:

? Raw Land
? Multi-Family Rentals
? Single-Family Rentals
? Retail Shopping Centers
? Office Buildings
? Industrial Facilities
? Storage Facilities
1031 Exchange Guidelines

To defer taxable gains via a Tenant in Common 1031 exchange, the following guidelines should be followed:

? The replacement property must be of equal or greater value than the relinquished property.
? The equity of the replacement property must be of equal or greater value than the equity of the relinquished property.
? The debt held by the replacement property must be of equal or greater value than the debt held by the relinquished property.
? All net profit from the relinquished property must be used in the purchase of the replacement property.

The strict identification and timeline rules for a 1031 exchange must be followed to the letter. The investor must identify in writing the TIC exchange properties within 45 days of the closure for the relinquished property in accordance with one of the following rules:

Three-Property Rule
Identification of up to three properties regardless of the total value of property identified.

200% Rule
Identification of any number of properties wherein the combined FMV (fair market value) does not exceed 200% of the relinquished properties' FMV.

95% Exception
Identification of any number of properties regardless of the aggregate FMV, as long as at least 95% of the property is ultimately acquired.

The investor must also close on the replacement property or properties within 180 days of the closure for the relinquished property or the tax filing date for the year in which the property was sold, whichever comes sooner.

It is required for the position of Qualified Intermediary (QI) to be filled by an uninvolved third party. The QI holds the proceeds from the relinquished property until they are reinvested in the exchange property. An "exchange agreement" must exist in writing between the QI and the investor, in order to prevent the investor from facing "constructive receipt" of the funds during the exchange period. The QI is required to complete a valid 1031 exchange and ensures that all roles are followed and equity is preserved during the process.

A 1031 tax deferred exchange may be used by investors as a powerful tool for building their wealth. A professional tax advisor should be utilized to ensure that all of the requirements of Section 1031 are met. Failure to do this can result in the cancellation of the capital gains deferral and result in immediate tax liabilities and associated penalties.
Section 1031 Process (Simplified)

A 1031 exchange is usually a three-way delayed exchange, referred to as a "Starker Exchange", in which an intermediary is used to facilitate the transaction. There are four basic steps to the process:

? Seller arranges for the sale of property and includes exchange language in the contract.
? At closing, sales proceeds are directed to a qualified intermediary to be held for exchange purposes.
? Seller identifies potential exchange properties within 45 days of the closing.
? Seller completes Section 1031 Exchange within 180 days of closing on their relinquished property.

In a Section 1031 transaction, these steps can occur simultaneously. Preferably, before you sell your property, you need to consider what type of replacement property will work best for you, and whether or not you want to own a whole or have partial interest in a property.

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