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A property transaction can only qualify for a 1031 Tax Deferred Exchange if it follows the rules laid down[...]
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1. Tax Rates Are High
2. Defer Payment of Taxes By Reinvesting
3. Tax Deferred but Not Tax Free[...]
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The taxpayer sells the property and retains the services of a Qualified Intermediary (QI). The following [...]
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A 1031 Tax Deferred Exchange is when a property owner sells their qualified property - known as the relinquished property - and reinvests the proceeds into another property or properties. The tax regulations state that real property must be exchanged for real property. These properties must be held for productive use in business, trade, or investment purposes. The 1031 Tax Deferred Exchange is sometimes referred to as a 1031 exchange real estate. This is the last tax shelter available. The theory behind the 1031 Tax Deferred Exchange is that because economic gain was not made in a way that requires a tax to be paid, the property owner's investment has not changed - just the form of the investment, i.e. a replacement property. For the purposes of this article, the property owner will be known as the "taxpayer".
For example, if the taxpayer sells Property "A" for $100,000.00 and realizes a $25,000.00 profit, then purchases Property "B" for $100,000.00, or more, then no taxes are required to be paid on the $25,000.00 profit from the sale of Property "A".
Be aware that not all real estate qualifies for a 1031 Tax Deferred Exchange. Most primary residences are not allowed by the IRS to participate in a 1031 Tax Deferred Exchange, since they are not primarily of a trade, business, or investment nature.
Also, there are time requirements for reinvesting, and specific documentation that must be adhered to. The replacement property must be designated within 45 days of the closing of the relinquished property, and/or closed within 180 days of the closing of the relinquished property.
To assure compliance with tax regulations, it is vital to involve an expert in 1031 Tax Deferred Exchanges, known as a Qualified Intermediary, or "QI". It does not matter where the QI is located - it does not need to be near either property.
The taxpayer must use the service of a QI and a wrong choice will disqualify the exchange. Disqualification will result if the taxpayer chooses any person who has a relationship with the taxpayer that would be presumed to be under control of the taxpayer. This would include the taxpayer's relatives, or anybody who is or has been the taxpayer's real estate agent, attorney, investment banker, or accountant within two years prior to the closing of the relinquished property.
It is required by IRS regulations that the proceeds from the sale be held in trust by a QI. The taxpayer cannot leave the funds from the relinquished property in escrow until a replacement property is found and purchased. Also, the taxpayer cannot leave the proceeds in an account that he/she even has indirect control or access to until the exchange property is acquired, such as a friend, attorney, employee or CPA, among others. When the taxpayer is ready to purchase a replacement property, the QI releases the funds to the seller of the replacement property and transfers the title of the replacement property to the name of the taxpayer.
1031 Tax Deferred Exchanges are usually made in commercial projects, such as shopping centers, office buildings, apartment complexes, etc.