With the recent surge in property values in Southern California, a growing percentage of taxpayers are seeking to take advantage of the gain non-recognition Section 1031 of the Internal Revenue Code to avoid or minimize the taxation of their gain on the disposition of business and investment properties.
Section 1031 states:
“No gain . . . shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind.”
There are some basic concepts involved that will be discussed here, including:
There must be a minimum of two properties in an exchange (one or more that you are selling, and one or more that you will acquire to replace them).
The properties must be held for use in a trade or business (for example, warehouse, industrial space, farmland, retail store, office building, etc.), or for investment (raw land, or a rental (single family residence, condo, or apartment). Keep in mind that the properties do not have to be identical. The examples above are considered “like kind” properties.
*NOTE: Personal property, such as your primary residence or vacation home does not qualify for a 1031 exchange!!!!
To be able to defer ALL of your gain on the disposition of your property, the purchase price of the new property must be equal to or more than the selling price of your disposed property, AND all of your sale equity (cash) must be reinvested in the replacement property or properties. Otherwise, if you keep any of the proceeds from the sale (called “boot”), then your gain will likely be taxed to the extent of your boot received. By the way, “boot” can consist of property received other than cash (usually personal property).Accommodator
1031 exchanges are tricky. If you receive any of the cash proceeds or take “constructive receipt” of the funds in any way, YOU WILL BE TAXED!!!!
This is why you must use an Accommodator who legally sells Property A to buy replacement Property B on behalf of the taxpayer, creating an exchange of properties. The taxpayer has the freedom to identify the specific property to sell and the property he wants to acquire (the latter within specified time limits….), but the Accommodator is the legal vehicle through which the properties are transferred.
The Accommodator must be an independent third party. He canned provide legal, tax or financial advice.Rules There are several rules that must be followed:
Prior to escrow closing on the sold property, the taxpayer must demonstrate his intent to perform an exchange through a written agreement with the Accommodator.
Within 45 days from the closing date of the “sold” property, the taxpayer must identify one or more potential replacement properties.
Within 180 days from the closing date of the “sold” property, the taxpayer must acquire one or more of the replacement properties where were identified during the 45 day period (as noted in “2” above).
We are associated with an Accommodation Company that specializes in 1031 exchanges. If you are contemplating doing an exchange, please contact me for further information.
IRS Recent Fact Sheet
The IRS posted this information concerning 1031 exchanges on their website in March 2008. It is reprinted below for your convenience.
Like-Kind Exchanges Under IRC Code Section 1031