A 1031 “Like Kind” Exchange (e.g., real property for real property) is a tax planning tool that if done correctly can allow a seller to defer having to pay all capital gains taxes to a future date. The general principles of a 1031 Exchange (with a St. Patty’s day twist) look something like this:
Marty and Mary Leprechaun decided to buy an investment property for 130,000 gold coins. A year and half after renting their home, Marty and Mary realized that they could sell their investment property for significantly more due to a heightened real estate market. After a bit of thought, some Irish stew, and a few green beers, Marty and Mary decided to list their investment property for sale with O’Doyles Rule Realty. Within 2 weeks of listing the property, Patty O’Doyle presented an “all coin offer” of 300,000 gold coins on a standard FR/BAR contract. While Marty was tipping back a fresh pint of ale to celebrate the offer Mary, generally the more responsible of the two, was concerned about the tax implications associated with making 170,000 gold coins over an 18-month span. Patty quickly informed Mary that she can speak to their accountant or real estate attorney to see if they qualify for a 1031 Exchange and determine the tax implications. Patty went on to say that, Standards Paragraph N of the FR/BAR contract requires both the Seller and Buyer to cooperate to effectuate the Exchange. Marty and Mary responded with “oh, thank my lucky charms!” and soon thereafter entered into a contract to sell their investment property.
After meeting with their tax advisor, Four Clover’s CPA, Marty and Mary realized that they qualified for a 1031 Exchange and were quickly brought up to speed on all of the requirements associated with performing the exchange correctly. Four Clover’s informed Marty and Mary that prior to the sale of their investment property they would need to understand a few things:
- They would need to locate and enter into an “Exchange Agreement” with a Qualified Intermediary (“QI”) to assist them in the sale. He mentioned that the QI is essentially a unrelated “middle man” that will assist them in the sale of their investment property (aka “relinquished property”), receive all of the capital gains from the relinquished property, acquire new property (aka “replacement property”), and then transfer their 170,000 gold coins to the closing agent on the closing date of their replacement property.
- Within 45 days following the sale of their investment property, Marty and Mary would need to provide (in writing) the QI with the potential replacement property (with specific legal descriptions or addresses). If Marty and Mary wished to identify multiple properties they would need to either:
- Identify up to three properties of any value with the intent of purchasing at least one.
- Identify more than three properties with an aggregate value that does not exceed 200% of the market value of the relinquished property.
- Identify more than three properties with an aggregate value exceeding 200% of the relinquished property, knowing that 95% of the market value of all properties identified must be acquired.
- Within 180 days from the sale of their investment property (or the due date [with extensions] of the income tax return for the tax year in which the investment property was sold; whichever is earlier) Marty and Mary would need to close one or more of the properties that they identified in writing to the QI.
The good news is Marty and Mary followed Four Clover’s advice. They identified a QI, provided the QI with potential replacement properties within 45 days of closing on their investment property, and closed on the replacement property (with a purchase price of 500,000 gold coins) within 180 days from the sale of their investment property. With Marty and Mary’s new found appreciation for this tax deferment strategy and a bigger pot of gold at the end of their rainbow they decided to celebrate in style with some corned beef and cabbage and a few pints of ale.
As always, should you have any questions in regards to 1031 exchanges we urge you to consult with your tax advisor or local real estate attorney.
Berlin Patten Ebling, PLLC
Article Authored by Jamie Ebling, Esq. firstname.lastname@example.org
This communication is not intended to establish an attorney client relationship, and to the extent anything contained herein could be construed as legal advice or guidance, you are strongly encouraged to consult with your own attorney before relying upon any information contained herein.
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