The delayed exchange is a unique investment technique that can only be used in real estate transactions.? You may sell your property today and reinvest the profits as long as six months later without having to pay the taxes due on the sale.? Taxes are deferred to a future date that you choose.? The 1984 Tax Reform Act provided Congressional approval of the concept of delayed exchanging by requiring that the investor identify his like-kind trade property within 45 days and complete the exchange by 180 days after the sale of his property.? The 1986 Tax Reform Act increased capital gains taxes and is responsible for a rapidly growing interest in the use of delayed as well as simultaneious exchanging.
The delayed exchange procedure came about when an investor named TJ Starker and his family attempted to trade timberland to the Crown Zellerbach Corporation in exchange for a promise to deliver suitable trade properties to the Starkers in the future.? The IRS challenged this transaction and after a series of tax court trials, the 9th Circuit Court of Appeals sided with Mr. Starker.? Needless to say, the IRS was not a happy camper with the decision and as recently as March, 1988, they stated that the court decision applied only to Mr. Starker and that the widespread use of delayed exchanges may create problems for many investors.? However, Regulations issued in 1991 validated the use of the delayed exchange on a national basis.? The delayed exchange is entirely legal, defensible, and has been used thousands of times over the years.
What is a like-kind property?
The Internal Revenue Code Section 1031 (a) (1) says, "no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged solely for property of a like kind to be held either for productive use in a trade or business or for investment."? What does the code really mean?? Property that is held for investment can be exchanged for any other property that is being held for investment and the investor will be allowed to defer paying capital gains taxes.
What are some properties held for productive use in a trade or business or for investment?? The list would include raw land, motels, office buildings, apartments, warehouses, and single family rentals to name a few.?? The way the code ready, any combination of these properties can be exchanged.? That means an apartment can be exchanged for an office building, a warehouse exchanged for a motel, and finally raw land exchanged for a single family rental.? In an exchange of real property for real property, the fact that any real property is improved or unimproved is immaterial, because that fact relates only to the grade or quality of the property and not to its kind of class.
Exchange Strategy
Investors buy real estate to earn a profit.? Decisions are carefully made to determine the effects of location, potential rents and expenses, financing and a multitude of other important factors in an attempt to realize as much of a profit as possible.? Once the profit is made, the typical investor sells his property, pays his taxes and reinvests in other real estate.? The vast majority of real estate investors seldom made use of the wealth-building advantages of the tax-deferred exchange.
Every investor knows that leverage creates wealth.? A 20% down payment can result in a 50% investment return because of leverage.? Tax deferment is also leverage.? Just as you use financing to leverage a purchase, you can use ta savings to acquire even greater wealth.? The 40% or more of capital gains taxes, which normally would be paid to the Federal and State government, can now be used to acquire larger properties.? An investor is able to accelerate his investment program by eight years or more by carefully developoping an investment strategy utilizing exchanges.
Exchanges are useful in a wide variety of circumstances.? They provide excellent opportunities for resourceful investors to create transactions which would not be possible througfh a sale/purchase format.? The overriding advantage of exchanging lies in the ability to move equity from property to property without having to pay the capital gains taxes.? Exchangaors can create an entire investment program using the wide variety of benefits available.
The steps of an exchange
1.? Exchangor finds a Buyer and opens escrow. 2.? Ownership to the Relinquished property is transferred to a 1031 qualified intermediary. 3.? Ownership is immediately transferred to the Buyer. 4.? At the close of escrow the proceeds are wire transferred from escrow to a designated bank.
The funds are held in a separate account set up for each specific transaction.? The first half of the transaction is completed at the close of escrow.? It is at this time that the Exchangor must locate a preplacement property within 45 days, and then complete the exchange within 180 days of the close of escrow of the Relinquished Property.
1.? Once the Replacement Property is located and is ready to close, exchange credits will be? wire transferred from the bank to the escrow handling the closing of the Replacement Property. 2.? Ownership to the Replacement property is transferred to a 1031 accommodator. 3.? Ownership to the Replacement property is then transferred to the Exchangor to complete the Exchange.
The exchange is completed with the Exchangor giving property to the Facilitator and in turn receiving a like-kind property.
The uses of trading are limited to the imagination of the investor and his advisor.? Almost any problem can be solved or objective reached more quickly by using the tax-deferred exchange.