ARTICLE

Lober Dobson & Desai LLC
Attorneys at Law
Atlanta | Macon

Email: info@lddlawyers.com

1031 EXCHANGES

In the world of business, Internal Revenue Code Section 1031 exchanges are a common tool used to defer capital gains taxes, dispose of investment property and use equity from one investment property to acquire replacement investment property. §1031 does not eliminate taxes, but rather defers them to a later time. This section of the Tax Code is highly regulated and therefore comes with a number of conditions that must be fulfilled in order for the IRS to accept the exchange. There are also a number of non-tax reasons that individuals choose to do §1031 exchanges including: to exchange a number of small properties for a larger one, to ease management responsibilities, to exchange for property that may be easier to sell in the coming years and exchange for property that the taxpayer can use in his or her own profession.

There are two types of property in §1031 exchanges: 1) the relinquished property - the property that is to be sold by the taxpayer and 2) the replacement property - the property that will be purchased by the taxpayer to replace the sold property. To qualify for a tax-deferred §1031 exchange, both the relinquished and replacement properties must be held by the taxpayer for investment purposes. Any attempt by the taxpayer to hold the property for personal use will prevent the property from qualifying for the exchange treatment.

In addition, the relinquished property must be exchanged for replacement property that is “like-kind.” Like-kind property refers to the nature or character of the property. For the most part, all real property is “like-kind” with all other real property. Some general examples of like-kind exchanges include, bare land can be exchanged for rental property; single family rental property for multi-family rental property; and a rental vacation home for a medical office in which the taxpayer intends to practice. Finally, all the proceeds from the relinquished property must be used to purchase the replacement property. If the taxpayer receives cash or other benefits from the transaction in hand, capital gains tax must be paid on that amount.

There are two important deadlines that the taxpayer has to adhere to in order to take advantage of the §1031 exchange:

(1) Identification Period:
the taxpayer must identify the replacement property to be acquired by the end of the exchange period within 45 days of the transfer of the first relinquished property.

(2) Exchange Period: the taxpayer must receive the replacement property within the earlier of (a) 180 days of the transfer of the relinquished property or (b) the due date, including extensions, for the taxpayer’s tax return for the tax year in which the transfer of the first relinquished property occurs.

As a taxpayer interested in a §1031 exchange, you should consult with your accountant, attorney and qualified intermediary. The qualified intermediary should be identified early in the sale process so that the transactions can be conducted in a timely manner. The accountant and attorney can advise you further regarding the tax effects and legal ramifications of your §1031 exchange, while the qualified intermediary will be the person or entity that holds the proceeds from the sale in a separate exchange account until the funds are used to purchase the replacement property.

 


 

 

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