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1031 Exchange Synopsis

1031 Exchange Basics

In the old days, you could sell property and “roll over” the proceeds without paying capital gain taxes.  But this is no longer true, at least for investment real estate.  There are many different factors, but this synopsis covers the basic of the 1031 exchange.

When an asset is sold for more than its original cost, there is gain which the IRS will tax at the “capital gains tax rate”. The amount of capital gain is calculated by taking the selling price of the asset minus its “adjusted basis” (i.e. the original cost of the property, plus any amounts expended for capital improvements minus depreciation) minus selling expenses.

A 1031 exchange, otherwise known as a tax deferred exchange is a simple strategy and method for selling one qualified property and then proceeding with the purchase or acquisition of another qualified property within a very important and specific time frame.  A “1031 exchange” is unique because the entire transaction is treated as an exchange and not just as a simple sale and then a later buy. It is this difference between “exchanging” and not simply buying and selling which, in the end, allows you to avoid or defer paying capital gain taxes to the IRS.

There are two important time frames that must be remembered;

  1. The Identification Period: This is the crucial period during which the party selling a property must identify other replacement properties that they wish to buy. This period is 45 days from the day of selling your property. This 45 days timeline must be followed under any and all circumstances and is not extendable in any way and is strictly enforced.
  2. The Exchange Period: This is the period when you must close title on the “exchanged” property.  It is referred to as the Exchange Period under 1031 exchange rule.   This period ends at exactly 180 days after the date on which you sell your property. This date can also be the due date for your tax return for that taxable year when you would have realized your capital gain on the property sold, whichever is earlier. So it is important to keep this deadline in mind and begin your search for a replacement qualified property early.

The actual mechanics of the exchange occur at closing.  In essence, the money or net proceeds of your sale will not go to you, but to a 3rd party, this party is called the Qualified Intermediary (QI). This middle man holds your money until you close on the replacement property.  As your proceeds money is never in your hands there will be no capital gain taxes due.

As the process has very important documents and time frame requirements, it is strongly suggested that you engage a professional with experience in this area.  Also important is the party selected to act as the Exchange.  Obviously you would want a reliable, insured third party to hold your money.

For additional information about 1031 exchange or other aspects of commercial transactions, please feel free to contact us at the Law Office of Michael K.W. Nolan, 732-202-9300 or through our website at www.lawnolan.com.

DISCLAIMER – Unless expressly stated otherwise nothing contained herein was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended.  Any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor with respect to any federal tax transaction.

How Lawyer’s Talk

A Lawyer’s translation of the phrase – “I give you an orange”

“Know all men by these presents that I hereby give, grant, bargain, sell, release, convey, transfer and quitclaim all my right, title, interest, benefit and use whatever in, of, and concerning this chattel, otherwise known as an orange, or citrus orantium, together will all the appurtenances thereto of skin, pulp, pip, rind, seeds and juice, to have and to hold the said orange together with its skin, pulp, pip, rind, seeds and juice for his own use and behoof, to himself and his heirs in fee simple, forever, free from all liens, encumbrances, easements, limitations, restraints or conditions whatsoever, and all prior deeds, transfers or other documents whatsoever, now or anywhere made to the contrary nothwithstanding, with full power to bite, cut, suck or otherwise eat the said orange or to give away the same, with or without skin, pulp, pip, rind, seeds or juice.”

For those interested – 145 words!

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