Tax Savvy Investing - 1031 Tax-Deferred Exchanges
by David Whisnant
This article is meant to be an introduction on the topic of performing
tax-deferred exchanges. There are a number of legal hoops that the IRS makes you
jump through to complete a tax-deferred exchange, but they are actually not that
complicated once you study up on them a bit.
A tax deferred exchange allows us to sell a piece of investment (i.e. rental),
trade or business property, buy a new property with the gain or profit from the
sale, and not owe taxes on the sale immediately. If you eventually sell the new
piece of property, you would owe taxes at that time. Generally, all gains and
losses on sales of real estate are taxable, but an exception lies where the
property sold is traded or exchanged for "like-kind" property. The new property
is seen as a continuation of the original investment, so taxes are not due at
the time of the sale.
Many people view tax deferred exchanges as being for huge corporations, or only
for professional investors. I believe that everyone should take advantage of
these where they can. Strategy -- purchase a rental home below market value,
rent it for a year, sell it, and buy two rental properties with your gain. Note
that if you do this too many times, the IRS may take the view that you are not a
long term investor, and disallow such exchanges. When you get ready to do a
tax-deferred exchange, you will need the services of a qualified CPA or
Attorney. This is a basic introduction only, and you should always get
professional advice from someone who has all the details on your deal, since so
much liability is at stake. In my course I list the company that I use for these
real estate exchanges. They are a national company and can help you out wherever
you are in the country. I have used them for several deferred exchanges, and
they have been an excellent resource and extremely competent.
Let's look at how one of these deals would work. Assume that you own a rental
property that has gone up in value. You'd like to sell this property and then
reinvest the proceeds into some other rental real estate. You can avoid the tax
bill if you can find suitable property to exchange for. The difficulty of the
tax deferred exchange is that the property you are going to purchase must be
identified within a certain amount of time, and it must be closed within a
certain amount of time after it is identified. Unfortunately, no extensions are
possible.
Identifying Property
You must identify property in a written document signed by you, and delivered to
the party assisting you with the exchange (cannot be related to you!) on or
before 45 days from the date you sold the original rental property. There is a
growing body of support for identification of properties, and closing of new
properties before the original property is sold. This is somewhat controversial
and outside the scope of this discussion.
Technical Note: You can identify more than one property as the replacement
property. However, the maximum number of replacement properties that you may
identify without regard to fair market value is three properties. You may
identify any number of properties provided that the total value of these
properties is not more than 200% of the value of the original property you are
selling. Note that you don't have to close on all the properties you identify.
You can name several if you're not sure what will close, or not close, but you
have to observe the rules in this technical note in terms of the value of
properties you identify. If at the end of the identification period you have
identified more properties than you are allowed, you are generally treated as if
no property was identified. This means that you pay taxes!
Time Limits For Completing the Exchange
If you have correctly complied with the identification phase of the exchange,
you have up to 180 days to complete an exchange, but the period may be shorter.
Specifically, property will not be treated as like kind property if it is
received more than 180 days after the date you transferred the property you are
relinquishing, or after the due date of your return (including extensions) for
the year in which you made the transfer.
For multiple property transfers, the 45 day identification period and the 180
day exchange period are determined by the earliest date a property is
transferred.
Avoid Boot!
Boot is defined as any money or any type of property of unlike kind (example, a
car received as part of down-payment). You will be taxed on this boot regardless
of whether or not you carry out the exchange correctly. You will want your
exchange company, or attorney to examine your transaction closely to make sure
you don't receive anything that could count as boot. Special rules apply for
exchanging property with assumed mortgages.
Summary
The tax-deferred exchange is a great way to maximize your wealth. By keeping
your investments growing without immediately paying taxes, you can do wonders
for your net-worth. You will need to search out a good intermediary. I am happy
to provide the name of mine for our members. This may seem like a dry subject,
but it is important to understand when you begin to accumulate some rental
properties.
Remember that this article is to provide basic information only. If you are
planning on doing a tax deferred exchange, you really need to speak with a
professional that handles these transactions on a regular basis. Information
here is subject to change by IRS regulations or statute, so be sure to use
current information provided by your accountant or other professional when
planning a strategy involving tax deferred exchanges.
Bio
Dave Whisnant is an Atlanta investor/attorney who is dedicated to
helping people land their first deals and create whatever level of success in
real estate that they desire.
After successfully building a real estate law practice, Dave walked away from it
to focus on real estate when he saw the profits that his clients were making.
Jumping in with both feet, he created a proprietary model that rocketed him to
the top of Atlanta investors almost from day one.
Dave is different than other investors in his single-minded quest to perfect a
series of cutting-edge prospecting tactics to locate and then land motivated
sellers who other investors are not even aware of.
A master investor AND teacher, Dave’s precise and easily duplicated systems have
been successfully implemented by his students around the country in competitive
markets of ALL kinds.
He believes in freely sharing his expertise and information for the benefit of
anyone who is serious about succeeding, and believes that his techniques will
create more success stories per student than any other real estate investing
coach in the world in 2006.
Real estate investing has enabled Dave to have the freedom that enables him to
spend time with his two young daughters, wife, and “herd” of golden retrievers.