What You Need to Know About 1031 Property Exchanges

 Posted on December 00, 0000 in Commercial Real Estate

Section 1031 of the Internal Revenue Code is one of the most powerful tools in the real estate investor's arsenal when looking to delay paying taxes. This section allows you to defer the payment of capital gains taxes or greatly reduce your tax liability. Section 1031 creates the ability for the creation of a “like-kind exchange”. You can either have a forward or a reverse exchange. This tactic only works for investment property and not for your personal home in most situations.

Forward Exchanges

In a forward 1031 exchange, you sell (or relinquish) your investment property and then within 180 days you close on a second property and use the proceeds from the sale to purchase the second property. If executed properly, the exchange will result in you not having to pay the capital gains on the proceeds from the first sale until you later completely cash out.

The major steps in a forward 1031 exchange are:

• You notify your real estate professional you plan on doing a 1031 exchange.
• You sell or relinquish your investment property.
• Closing paperwork and Notice of Assignment is executed.
• The proceeds of the transaction are placed in escrow.
• Within 45 days after the first closing, the replacement property is identified.
• The new property is purchased, and closing is completed within 180 days of the closing of the first property.
• The 1031 exchange documents are executed.

If you have money left over from the sale of the first property that is not needed to purchase the second property, sometimes called the boot, this money will be taxed.

Reverse Exchanges

The biggest difference between a reverse exchange and a forward exchange is the timing. In a reverse 1031 exchange the new property, or replacement property, is purchased before the first property is sold. This type of exchange requires the help of what is called an Exchange Accommodation Titleholder (EAT).

An EAT is basically a holding company created for the sole purpose of parking the newly acquired property until the original property is sold and the exchange is completed. The EAT must be set up correctly for the investor to get the tax benefits of a reverse exchange.

The major steps in a reverse 1031 exchange are:

• Consult with a real estate professional to assess the financial and tax justifications for a reverse exchange.
• Establish an EAT.
• Purchase the second or replacement property.
• 1031 exchange documents are executed.
• The EAT takes possession of the second property.
• The old property is identified as part of the exchange if necessary.
• The old property is sold.
• As part of closing the new property parked in the EAT is transferred out to the investor.
• The 1031 exchange documents are executed.

A reverse 1031 is more complicated than a forward exchange and requires more documentation. If a mistake is made anywhere along the way, it could jeopardize everything from your financing to your tax liability.

Before you begin a 1031 exchange, talk to an experienced and knowledgeable Naperville commercial real estate attorney to discuss the tax implications of any sale or purchase. Call Lindell & Tessitore, P.C. at 630-778-3818 today to schedule an appointment. It is critical that you meet the time deadlines and execute the correct documents or you could be facing a large tax liability.

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