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Use
a tax advisor. The tax
rules concerning exchanges must be complied with exactly. If you
do things wrong, you may have to pay tax on your entire exchange.
You also may be liable for interest and tax penalties. You are
urged to consult with a qualified tax advisor before signing any
agreements pertaining to an exchange.
Basic exchange
terminology. A number of basic terms are important when you try
to discuss deferred exchanges:
- "Deferred
Exchange" means an exchange qualifying for non- recognition
under Section 1031 of the Internal Revenue Code where there is
a gap in time between your transfer of relinquished property and
your receipt of replacement property. ,
- "Taxpayer"
means the person who is trying to accomplish the deferred exchange.
- "Relinquished
Property"
means your property that you give up in the exchange that qualifies
for like-kind exchange treatment.
- "Replacement
Property" means the like-kind property that you receive
in the exchange.
- "Intermediary"
or "Qualified Intermediary"
A qualified intermediary operates under a specially drawn
contract with the EXCHANGER. This contract agreement enables the
qualified intermediary to purchase and sell properties on behalf
of the EXCHANGER for a fee for services.
- "Identification
Period"
means the period during which you must identify replacement property,
beginning on the day on which you transfer your relinquished property
and ending on midnight of the 45th day after that.
- "Exchange
Period"means the period during which you must actually
acquire the replacement property, beginning on the day on which
you transfer your relinquished property and ends on the date that
the tax return of the taxpayer is due, including extensions, or
in 180 days, whichever is earlier.
- "Exchange
Balance"
means net value of your replacement property, that is deposited
with your qualified intermediary.
- "Boot
and Taxable Gain" Cash, notes, and unlike property
in an exchange is called boot. Receiving boot as part of an exchange
does not defeat the non-taxable provisions of Section 1031. However
if you receive boot, you probably will have taxable gain. If the
other party assumes any of your liability as part of the exchange,
it will be treated as if you received cash. The only practical
way for the majority of investors to avoid boot is the use of
a "Qualified Intermediary".
- "Disqualified
Person to serve as Qualified Intermediary". Related
parties such as a spouse, ancestors, descendants, siblings, or
the EXCHANGER'S employees, attorney, accountant, investment banker,
broker, or real estate agent. And related corporations or trusts
where 10% or more of the stock or ownership is owned directly
or indirectly by the Exchanger.
- "Direct
Deeding"
means
a transaction where you deed your relinquished property directly
to your buyer (and not to your qualified intermediary) or where
your seller of replacement property deeds that property directly
to you.
- "Tax
Basis"
or "Basis"
For the purposes of a 1031 exchange, basis is the term we give
to the price which was originally paid for the relinquished property,
less any depreciation, plus any costs to improve that property.
Example: A property you bought ten years ago for $30,000 that
you've been depreciating at $1,000 a year for the last ten years
would now have a basis of $20,000. The basis of the replacement
property becomes the same as the basis of the relinquished property,
plus any amount paid in excess of the adjusted sale price of the
relinquished property. The adjusted sales price is the price the
property sold for, less the selling cost, and less any other cost
to make the property ready to sell. Example: You sell a property
for $100.00 with a basis of $20,000, and you buy a replacement
property for $150,000. You paid $50,000 more for the new property,
so the basis on your new property is now $70,000. Also any expenses
which you pay to acquire the replacement property are added to
the new basis. These costs would include the real estate commission,
and other regular closing costs.
How can
you structure an exchange with a qualified
intermediary? A qualified intermediary is someone who
facilitates your exchange. Most intermediaries are corporations
affiliated with title companies or escrow companies that are in
the full-time business of offering qualified intermediary services.
As such, the role of a qualified intermediary is a little like (but
certainly not identical to) the role of an escrow company or settlement
attorney. For a deferred exchange, you must enter a written agreement
with a qualified intermediary that provides that:
- you will
transfer your relinquished property to your qualified intermediary,
- your qualified
intermediary will sell your relinquished property to your buyer,
- your qualified
intermediary will acquire the replacement property that you identify,
- the replacement
property that you identify must be real property that you will
hold for investment or for use in your trade or business and that
will qualify for a like-kind exchange under Section 103 1 of the
Internal Revenue Code,
- your qualified
intermediary will retransfer your replacement property to you
as the consideration for your relinquished property, and
- your qualified
intermediary cannot transfer any cash or other "boot" to you from
the sale of your relinquished property, and you may not receive,
pledge, borrow, or otherwise obtain the benefits of cash or other
property held by your qualified intermediary (other than your
replacement property) until the end of the exchange.
The exchange
agreement will credit you with an exchange balance equal
to the net sales price of your relinquished property. It will permit
you to identify replacement property with a net value equal to your
exchange balance. Finally, if you do not acquire enough replacement
property to use up your exchange balance, the exchange agreement
will require your qualified intermediary to pay you the remaining
exchange balance in cash at the end of the exchange.
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