What Is a 1031 Exchange?
If you are considering selling your investment property to buy another one, you should learn more about the 1031 tax-deferred exchange. Based off of Section 1031 of the U.S. Internal Revenue Code, a 1031 exchange will allow you to avoid paying capital gains taxes when you sell investment property and reinvest the proceeds in a property or properties of like kind and equal or greater value (within a certain time frame).
What Are the Steps For a 1031 Exchange?
Contact Provident Title & Escrow (PTE)
PTE opens your file and provides you with exchange instructions
PTE provides exchange documents to your closing company
Property is sold and funds are wired to PTE
You have 45 days to identify the new investment property(s)
You have 180 days to purchase your new investment property(s)
PTE forwards exchange funds and documents to your closing company
For more detailed information, you can also see our 1031 Timeline.
Important Terms to Understand
Relinquished Property: Your existing investment property that you sell first
Replacement Property: The property you acquire with the proceeds from selling your relinquished property
Qualified Intermediary (QI): The designated “middle man” who holds the proceeds from your relinquished property. The QI will then transfer funds to close the sale on your replacement property.
Like-Kind Property: Property that is of similar nature to another. In order to qualify for a 1031 exchange, your replacement property must be held for investment, not resale or personal use. Some examples include exchanging vacant land for a commercial building, or exchanging industrial property for residential property.
What Are the Benefits of a 1031 Exchange?
The main benefit of a 1031 tax-deferred exchange is the tax deferral. By deferring the capital gains tax, it frees up more capital for you to invest in your replacement property.
To maximize your benefits, your replacement property should be of equal or greater value. Increased purchasing power gives you the extra leverage to acquire an investment property(s) with higher investment benefits to you.
You should also consider 1031 exchanges for your estate planning, especially since the tax deferment wipes out upon your passing. This means that you heirs can receive any of your unsold property obtained through a 1031 exchange with a higher market rate value and deferred taxes erased. Our offices at Provident Title & Escrow also provide comprehensive estate planning services.
PTE 1031 EXCHANGES
PTE Exchange LLC offers its services as a Qualified Intermediary for Internal Revenue Code (IRC) Section 1031 tax deferred exchanges. To achieve a successful tax deferred exchange the IRC requires the use of a Qualified Intermediary to facilitate the exchange. PTE Exchange is fully insured and a member in good standing with the Federation of Exchange Associates. PTE Exchange was founded in 2001 and has assisted hundreds of taxpayers with their 1031 tax exchange.
PTE Exchange Services can act as a Qualified Intermediary for an exchange in any of the 50 states and the District of Columbia. Selling in one state and purchasing in another state is no problem. Because of the strict guidelines associated with a 1031 tax exchange, it is important to understand how the exchange process works, and to discuss your particular situation with an accountant or other tax advisor prior to beginning the exchange process.
Please feel free to download sample 1031 documents by clicking on our 1031 Downloadable Forms tab. Email Jrichter@jrichterlaw.com or call us at 703-239-0650 with any 1031 Exchange related questions.
IRC SECTION 1031 INFORMATION
As a Qualified Intermediary, PTE Exchange LLC (PTE) will help guide the Exchanger through an IRC tax deferred exchange. PTE will prepare all of the necessary exchange documents and work closely with the company conducting the settlement on the sale of the relinquished property and the purchase of the replacement property.
Upon the sale of the relinquished property, the settlement company will transfer the net proceeds to PTE to be held until the purchase of the replacement property. Normal settlement charges may be deducted from the exchange proceeds including realtor commissions, transfer taxes and other fees negotiated in the sales contract.
Once the net sale proceeds have been wired into the PTE trust account, the funds can be placed into an interest earning account. Interest earned is considered income to the Exchanger and is not included in the exchange funds. PTE Exchange will disburse all interest earned directly to the Exchangee. The interest earned is separate from the Exchange funds.
Once the settlement is conducted on the relinquished property, the Exchanger has 45 days from the settlement date to identify the replacement property. Under Treasury Regulations issued by the Internal Revenue Service related to a Section 1031 tax-deferred exchange, there are stringent requirements regarding the identification of replacement property in a tax-deferred exchange. These requirements must be satisfied before the expiration of 45 days. No extension of time is permitted, even if the 45th day happens to fall on a Saturday, Sunday or legal holiday. THIS IS EXTREMELY IMPORTANT.
There are two ways in which one can identify the replacement properties. The 3-Property Rule allows one to identify three properties regardless of their value. The second way to identify replacement properties is by using the 200% Rule. This allows one to identify more than three properties provided the aggregate fair market value of these properties does not exceed 200% of the aggregate fair market value of all of the relinquished property. The fair market value of the replacement properties must be determined by the 45th day after the sale of the relinquished property and the fair market value of the relinquished property is determined on the date the property is transferred. The Exchanger is not required to actually acquire all of the replacement property identified if these rules are followed.
There are serious consequences if either the 3-property rule of the 200% rule is not adhered to. PTE recommends the Exchanger choose the 3-property rule and identify either two or three properties as the replacement property so that if the Exchanger is unable to close on the acquisition of the preferred replacement property, the Exchanger will have timely identified one or two alternative replacement properties which may be acquired instead.
Any type of replacement property may be identified (i.e., single family rental property, duplex, apartment building, hotel, office building, warehouse, commercial building, vacant land, etc.) so long as the replacement property is to be held for productive use in trade or business or for investment. Property in any state of the United States or the District of Columbia may be identified.
After identifying the replacement property, the IRC requires the purchase to take place (1) prior to midnight of the 180th day after the date of the sale of the relinquished property or (2) prior to the due date (including extensions) of the Exchanger's federal income tax return for the taxable year in which the transfer of the relinquished property occurs. There are no exceptions to these rules.
The fee paid to the PTE Exchange, LLC, is for the sole purpose of drafting the Exchange Agreement, acting as the Qualified Intermediary and explaining the basic concepts of how a tax-deferred exchange occurs. The normal fee for a standard 2 party exchange is $750.00. PTE does not act as a tax advisor and strongly suggests that you consult your CPA or tax specialist concerning the specifics of your transaction.
Please contact PTE Exchange at 703-239-0650 if you would like tax exchange assistance.
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