1031 Exchange

Aloha! and welcome to the 1031 Exchange section of my website, here you will find many advantages of using your Tax Deferred Exchange Program that the IRS has allowed us to use as investors.

The 1031 Exchange

The tax deferred exchange, as defined in Section 1031 of the Internal Revenue Code of 1986, as amended, offers investors one of the last great opportunities to build wealth and save tax's. By completing an exchange, the investor (Exchanger) can dispose of their investment property, use all of their equity to acquire replacement investment property, defer the capitol gain tax that would ordinarily be paid, and leverage all of their equity into the replacement property. Two requirements must be met to defer the capital gains tax : (a) the Exchanger must acquire "like kind" replacement property and (b) the Exchanger cannot receive cash or other benefits (unless the Exchanger pays capitol gains taxes on his money).

In any exchange the Exchanger must enter into the exchange transaction prior to the close of the relinquished property. The Exchanger and the Qualified Intermediary enter into an Exchange Agreement, which essentially requires that (a) the Qualified Intermediary acquires the relinquished property from the Exchanger and transfers it to the buyer by direct deed from the Exchanger and (b) the Qualified Intermediary acquires the replacement property from the seller and transfers it to the Exchanger by direct deed from the seller. The cash or other proceeds from the relinquished property are assigned to the Qualified Intermediary and are held by the Qualified Intermediary in a separate, secure account. The exchange funds are used by the Qualified Intermediary to purchase property for the Exchanger.

Exchange Period : The exchanger must receive the Replacement Property within the earlier of 180 days after the date on which the Exchanger transferred the first Relinquished property, of the due date (including extensions) for the Exchanger's tax return for the tax year in which the transfer of the first Relinquished Property occurs.

Identification Period: The Exchanger must identify the Replacement Property to be acquired by the end of the Exchange Period within 45 days of the Relinquished Property.

The time periods for the 45-day Identification period and the 180-day Exchange Period are very strict and cannot be extended even if the 45th day or 180th day falls on a Saturday, Sunday or legal holiday.

The Reverse Exchange

A reverse exchange is the "flip side" of a deferred (delayed) exchange. In a reverse exchange the Exchanger for various reasons must acquire their like-kind replacement property before disposing of the relinquished property. Until recently it was unclear whether reverse exchanges would be given nonrecognition treatment by the IRS. However, on September 15, 2000, that question was answered by the IRS in the form of Revenue Procedure 2000-37 (Rev.Proc.2000-37"). This Revenue Procedure provides that tax deferral on a reverse exchange will be recognized if the transactions fall within the scope of an announced IRC 1031.

Non-Tax Reasons to Exchange

Generally, investors complete tax deferred exchanges to defer capitol gains tax on disposition of their investment properties. However, there are many additional underlying reasons an investor might want to exchange one property for another. The motives often fall along standard risk-reward or cash flow-appreciation scales. These are some of the typical non-tax motives to exchange:

Exchange from fully depreciated property to a higher value property that can be depreciated.

Exchange from property that cannot be refinanced. For example, moving from vacant land to improved property, which can support a new refinance loan, and will thereby giving you the ability to obtain cash after acquisition of replacement property.

Exchange from non-income producing raw land to improved property to create a positive cash flow from the rental income.

Exchange from a property with maximized or minimal cash flow (an apartment building) to a higher cash flow property (a retail shopping center) to generate larger cash flow.

Exchange for a property or properties that may be easier to sell in the coming years.

Exchange from a stagnant or slowly appreciating property to a property in an area with faster appreciation.

Exchange from several smaller properties to one large property to consolidate the benefits of ownership and reduce management responsibilities.

Exchange from a larger property to several smaller properties. Exchanges can be used to divide an estate among several children or for retirement reasons.

Exchange to a property that you can use in your own profession. For example, a doctor may exchange from a rental house to a medical building to use for his/her practice.

This information is very valuable and can save you thousands of dollars on your tax's, did you know you can trade your rentals for your dream property here on Maui? all you do is follow all guidelines set forth by the IRS. For example, you may consider buying a luxury property here on Maui, you will be required to establish it as a "rental" for 2 years, at the end of the required "rental period" you are allowed to move into the property, you must occupy the property as your "personal residence" for a minimum of 3 year's, with the total ownership of the property being 5 years. At the end of all requirement's, if properly executed, the IRS will allow a $250,000.00 tax exemption for singles, and a $500,000.00 tax exemption for married couples! so now you know what to do with all those rentals, don't sell them, trade them!

Again, if you would like more information on the 1031 Exchange Program and a referral to an Exchange Specialist please feel free to contact me anytime.

Happy Investing!

Richard