What is a 1031 Exchange?
The 1031 Exchange allows you to sell investment real estate or other business assets and defer the payment of your capital gain taxes by acquiring like-kind replacement property. 1031 Tax Deferred Exchanges allow you to keep 100% of your equity in productive use, rather than paying 20-33% of your gain in taxes, provided you follow very specific qualification requirements.
Why use a 1031 exchange?
A tax-deferred exchange allows you to sell rental or investment property and purchase other property that may fit your lifestyle better, be more profitable or better positioned for future growth opportunities, while deferring Federal, and in most cases state, capital gain and depreciation recapture income tax liabilities. The deferred taxes mean that your money continues to produce revenue for you, even as you change investment vehicles.
What’s an example of the actual savings from a 1031 exchange?
If we assume that in 2013 you have $300,000 in taxable gain at the time of sale, then a 1031 exchange allows the roughly 23.8% in capital gains and passive income taxes to be deferred ($71k) and placed into productive use in a replacement property.
Your savings from the 1031 exchange is NOT ONLY the $20-33k in deferred taxes, but also the additional appreciation generated by keeping your money in productive use. As long as your annual asset appreciation remains positive, then your 1031 savings grow every year that the money remains invested.
What are the main rules to keep in mind for a proper 1031 exchange?
The most important rules for the 1031 are timing of the events during the exchange, the identification of the replacement property and the fact that the exchanger can never take constructive use of any sale’s proceeds. Failure to comply with these rules are the most common reasons for a failed 1031 exchange. Using a Qualified Intermediary, however, greatly facilitates your ability to complete the 1031 exchange properly. Southern Exchange Services has been active in the New Orleans area market for 15 years, and can guide you through this complex process.
What is a Qualified Intermediary?
A Qualified Intermediary is an independent agent who facilitates tax-deferred exchanges by following the rules set out in Section 1031 of the Internal Revenue Code. The QI cannot be the exchanger or a disqualified person. The QI’s job is to maintain the separation of proceeds from the constructive use by the exchanger until the replacement property has been acquired. Additionally, the QI can be instrumental in conducting reverse or build-to-suit exchanges, which are complex and need a third-party to properly administer.
What is Boot?
Boot is an old English term meaning “Something given in addition to.” “Boot received” is the money or fair market value of “Other Property” received by the taxpayer in an exchange. Money includes all cash equivalents, debts, liabilities or mortgages of the taxpayer assumed by the other party, or liabilities to which the property exchanged by the taxpayer is subject. “Other Property” is property that is non-like-kind, such as personal property, a promissory note from the buyer, a promise to perform work on the property, a business, etc.
There are many ways for a taxpayer to receive “Boot”, even inadvertently. It is important for a taxpayer to understand what can result in boot if taxable income is to be avoided.