1031 Tax Deferred Exchanges

Every Section 1031 Exchange transaction is different. These "Frequently Asked Questions" are intended to answer general inquiries. The application of these principles will depend on the specific facts of each transaction. Always consult a competent Qualified Intermediary, attorney, or tax advisor to determine how an exchange may best be structured to accomplish your investment objectives. [“Federation of Exchange Accommodators”]

Q - What is a tax-deferred exchange?

In a typical transaction, the property owner is taxed on any gain realized from the sale. However, through a Section 1031 Exchange, the tax on the gain is deferred until some future date. Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of "like-kind", while deferring the payment of federal income taxes and some state taxes on the transaction.

The theory behind Section 1031 is that when a property owner has reinvested the sale proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. In other words, the taxpayer's investment is still the same, only the form has changed (e.g. vacant land exchanged for apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a "paper" gain.

The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

Q - What are the benefits of exchanging v. selling?

• A Section 1031 exchange is one of the few techniques available to postpone or potentially eliminate taxes due on the sale of qualifying properties.
• By deferring the tax, you have more money available to invest in another property. In effect, you receive an interest free loan from the federal government, in the amount you would have paid in taxes.
• Any gain from depreciation recapture is postponed.
• You can acquire and dispose of properties to reallocate your investment portfolio without paying tax on any gain.

Q - What are the general guidelines to follow in order for a taxpayer to defer all the taxable gain?

• The value of the replacement property must be equal to or greater than the value of the relinquished property.
• The equity in the replacement property must be equal to or greater than the equity in the relinquished property.
• The debt on the replacement property must be equal to or greater than the debt on the relinquished property.
• All of the net proceeds from the sale of the relinquished property must be used to acquire the replacement property.

Purchase Real Estate in your IRA or 401K

You can invest IRA money in a wide range of investments, including stocks, bonds, mutual funds, money market funds, saving certificates, U.S. Treasury securities, promissory notes secured by mortgages or deeds of trust, limited partnerships and real estate. That includes houses, condos, office buildings -- even if located in another country.

You cannot use IRA money to buy your own residence, or any other property in which you live. It has to be investment property. But when you retire, you can direct your IRA to turn it over to you as a distribution, at the current market value.

Seller/Owner Financing

When part or all of the purchase price, less the buyer's down payment, is carried by the seller. It doesn't matter if the property has an existing loan, except to the extent that the existing lender might accelerate the loan upon sale due to an alienation clause. Instead of going to the bank, the buyer gives a financing instrument to the seller as evidence of the loan and makes payments to the seller. The buyer and seller are free to negotiate the terms of the owner financing and agree upon an interest rate, monthly payment amount and term of the loan, and the buyer pays the seller on an installment basis.

While there is no standard down payment required, many sellers want a sufficient down payment to protect their equity. Down payments can vary from little to 30% or more. Sellers feel their equity is safeguarded by the buyer's down payment because buyers are less likely to go into foreclosure if they've invested a lot of money upfront. The security instrument is generally recorded in the public records, which protects both parties. Some variations of owner financing include land contracts, promissory notes & mortgages, and lease purchase agreements. Owner financing benefits for buyers include little or no qualifying, tailored financing, down payment flexibility, lower closing costs and faster possession. Benefits for sellers include higher sales price, tax breaks, monthly income, higher interest rate and a shorter listing term.

Contact us to take advantage of this type of creative financing and we’ll send you a list of properties offering this option.

Lease Option

Buyer pays the seller option money for the right to later purchase the property. The lease option money may be substantial.

• Buyer and seller may agree to a purchase price now or the buyer may agree to pay market value at the time the option is exercised. It is negotiable. However, most buyers want to lock in the future purchase price upon inception of the lease option.
• During the term of the lease option, the buyer agrees to lease the property from the seller for a predetermined rental amount.
• The term of the lease option agreement is negotiable, but the common length is generally from one year to three years.
• The option money generally does not apply toward the down payment.
• A portion of the monthly rental payment typically applies toward the purchase price.
• Option money is rarely refundable.
• Nobody else can buy the property during the lease option period.
• The buyer generally cannot assign the lease option without seller approval.
• If the buyer does not exercise the lease option and purchase the property at the end of the lease option, the option expires.
• The buyer is not obligated to buy the property

Lease Purchase Option

Buyer pays the seller option money for the right to later purchase the property. This option money may be substantial.

• Buyer and seller agree on a purchase price, often at or a bit higher than market value.
• During the term of the option, the buyer agrees to lease the property from the seller for a predetermined rental amount.
• The term of the lease purchase agreement is negotiable, but the common length is generally from one year to three years, at which time the buyer applies for bank financing and pays the seller in full.
• The option money generally does not apply toward the down payment.
• A portion of the monthly lease payment typically applies toward the purchase price.
• Option money is nonrefundable.
• Nobody else can buy the property unless the buyer defaults.
• The buyer typically cannot assign the lease purchase agreement without seller approval.
• Buyers are often responsible for maintaining the property and paying all expenses associated with its upkeep, including taxes and insurance.
• The buyer is obligated to buy the property.

Real Estate for Exchange/Trade

This is a great option for those that need to move or own second home while waiting for another home to sell. Trading property in the mountains is not a common practice but is made available by a small number of sellers and usually means that the seller is motivated and ready to move on.

Fractional Ownership

A type of ownership, similar to any other real estate purchase, except that you are only purchasing a fraction of the property instead of the whole property. This is often a great option for those who would like a vacation home but are but are not able to spend enough time there to warrant the purchase. Fractional ownership is a middle ground solution to second home ownership. It is whole ownership, with sole responsibility and full exclusive use. Fractionally owned properties tend to be far more exclusive and luxurious and also tend to appreciate in value versus a time-share situation.

Fractional Ownership consists of owning an undivided fractional fee-simple interest in a specific property. Fractional vacation homes have the appeal of defraying costs by sharing them with other and the fractional shares can vary depending on the property.