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IRC Section §1031 Exchange
General Rules and Timelines

What is an IRC Section §1031 Exchange?

 

“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.” - IRC Section §1031

 

Whenever you sell a business or investment property and you have a gain, you generally must pay tax on the gain at the time of sale.  IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange.  Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free.

Happy Couple
Meet Arthur and Linda Blank
Investment Real Estate Owners

Arthur and Linda have owned a multifamily property for the past 10 years which has appreciated significantly and provided stable monthly income.

 

They are both turning 65 next year and would like to eliminate all real estate management responsibilities.  Since their property has appreciated in value they feel now is a good time to sell.

 

Their objective is to maintain the income they have been accustomed to and leave as many assets as possible to their daughter Jane upon their passing.

 

A friend has told them that doing a 1031 exchange could help defer taxes and allow them to keep their full equity base intact to maximize future income.  They would like to know what a 1031 exchange is and what their options are.

Exterior of a Building

Option 1 - Taxable Transaction

Sell the property, pay the taxes and use the proceeds to invest in another income producing asset

Upon sale of the property Arthur and Linda would be subject to sizable taxes on their capital gain

After-Tax Proceeds

Taxation on sales proceeds would diminish the equity base used to generate future income.

Potential Real Estate Taxes

  • Federal Capital Gains Tax

  • Depreciation Recapture

  • State Tax

  • Net Investment Income Tax

Option 2 - 1031 Exchange

Upon the sale of the property, Arthur and Linda would have the proceeds of the relinquished property sent directly to a Qualified Intermediary.  The clock starts ticking!

The Qualified Intermediary (QI); also known as an exchange facilitator; maintains cash proceeds in an escrow account and helps to ensure that all 1031 requirements are met

Professional Female

1031 Exchange Process& Timelines

Commercial Buildings

Property Sold

45 Days to identify replacement property

180 Days to close escrow on replacement property

Exchange

Timeline

Properties must be "like Kind".  Generally, any real estate held within the United States for business or investment purposes is considered like-kind regardless of type, grade or quality.

Property

Requirements

The QI officially records the date and time of property identification prior to midnight on the 45th day

The QI uses the proceeds from the relinquished property to close escrow on the replacement property prior to midnight on the 180th day

Role of the QI

Professional Female
Property Identification Rules

When identifying replacement property an investor can utilize one of the following rules:

3 Property Rule - Identify up to three potential replacement properties and purchase any (or all) of them, regardless of their total value, to complete the exchange

200% Rule - Identify more than three potential replacement properties if their combined total value does not exceed 200% of the value of the relinquished property.  Purchase as many of the identified properties as one wants.

95% Rule - Identify any number of potential replacement properties regardless of their value as long as at least 95% of the total value of all of the properties identified are purchased

To Defer Taxes Fully

  ○  All proceeds from the sale of a relinquished property must        be reinvested in replacement property

  ○  An investor must assume an equal or greater amount of

      debt than that which was held on he relinquished property

    The title on the replacement property must be identical to        that of the relinquished property

These are just a few of the considerations when conducting a 1031 exchange.  Please consult your Tax Advisor and Qualified Intermediary for more information regarding IRC Section 1031 exchange rules and regulations.  Alternative Wealth Management does not provide tax or legal advice.

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All securities offered through Patrick Capital Markets, LLC Member FINRA / SIPC.  Investors should review any transaction and the various tax deferred and tax exclusion strategies and structures available with their tax and legal advisors.  Alternative Wealth Management does not provide tax or legal advice to individual investors.

The information provided in this website is for educational purposes only and does not represent an offer to purchase, acquire or engage in any transactions.  Securities discussed above would only be purchased through Private Placement Memorandum.  Securities and strategies discussed herein may be speculative and entail a high degree of risk.  Investments in Private Placements are suitable only for investors who have adequate means of providing for current needs and personal contingencies, can bear the economic risk of the investment, and have no need for liquidity.

The following is a brief overview of some of the risks that Alternative Wealth Management deems appropriate to highlight.  It is not and is not intended to be, a summary of all the risks associated with the strategies and securities discussed herein.

Delaware Statutory Trusts (DSTs) - DSTs are regulation D private placements that offer fractional ownership of real estate.  Investors should understand the risk factors of participating in such investments as outlined in this section in addition to the private placement memorandum; in particular real estate risks, liquidity risk, change of tax status among others.

Real Estate Risks – Real estate risks include those of specific property issues, the economy of the geographic locations, environmental hazards, the risk of loss of tenant and other factors typically associated with a real estate investment.

 

​Change of Tax Status - IRS tax rule changes may alter or eliminate certain benefits related to current strategies.

Performance Expectations – There is no guarantee that the investment and tax strategies discussed will elicit the optimal results.  Each taxpayer is unique.  Past performance or the results of other individuals is never an assurance of future results.

Reduction or Elimination of Cash Flow – Investments in real estate may experience temporary or permanent disruption of cash available for distributions, such as, from a reduction in tenant payments or if the property sustains substantial damage.

 

Potential for Property Value Loss - All real estate investments have the potential to lose value during the life of the investments.

 

Impact of Fees/Expenses – There may be substantial fees paid to Sponsors, affiliates, and others, related to the strategies and securities discussed herein and such fees typically are paid regardless of the performance of the investment or strategy you seek.    Such fees and costs may impact investor returns and may outweigh any anticipated tax benefits.

 

Liquidity Risk – Private Placements are il-liquid with no secondary market.  You should consider these long-term investments regardless of your circumstances.

 

Sponsor Risk – There are substantial conflicts of interest between investors and the self-interest of the Sponsor, Master Tenant, affiliate companies and others who will profit from the private placement for their services regardless of their results.  Their decisions related to the offering and operation of the private placement is critical to the success of the private placement and the return of your investment.  The offering sponsor could take actions that might not be in the best interests of the shareholders of the private placement.  Those types of conflicts of interest could influence the decisions in the management and operation of the private placement that are contrary to the best interests of the Investors.  Investors will have no control over their decisions.

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