Basic Exchange Guidelines and Definitions
Here are some basic guidelines and definitions you should be familiar with. Contact us for more details as there are several variations for particular exchange situations and proven “best practices” which will add value to your exchange process.
Like-kind refers to the types of properties you can exchange. You can exchange from property held for investment into other property held for investment. Property held for business use can be exchanged into other property held for business use. For example; you can exchange from apartments, to single tenant net leased properties. You cannot exchange a property that was held for investment, for a property to be used for personal use. You can exchange from land which was held for investment to income property held for investment. You cannot exchange investment property for land to develop and sell as lots. That is referred to as dealer activity and is normally taxed.
The intermediary is the third party who temporarily holds the funds and property. The 1031 exchange process involves the participation of an intermediary third party who acts as a middle man who affects the 3 way trade or exchange of properties and funds. You cannot receive or hold the cash from the sale of the relinquished property. The intermediary must hold the funds until you close on the replacement property. The costs are minimal, as low as $500 for a simple transaction. The firm holds the funds and provides the paperwork to properly facilitate the exchange. There are several safe intermediary firms around the country and some not so safe. If the intermediary handles your transaction improperly, or handles other transactions improperly, your transaction could possibly have some unpleasant tax consequences. For example as an improper practice, your intermediary cannot also act as your broker.
The relinquished property is the property or properties you are selling. The replacement property is the property or properties you are acquiring.
The cash proceeds from the sale of the relinquished property is called boot. It’s important to note, you can add additional cash into the acquisition of replacement property. This opens up more possible replacement property options. To fully defer the transaction from taxes, all the cash or boot must be reinvested into replacement property. So if your boot is $100,000, you must invest at least all the $100,000 boot on replacement property. If you want to use some of the boot for another purpose, for something fun like a boat, or for a business or stock investment, we have found some ways to accommodate those needs safely within the 1031 guidelines.
A simultaneous exchange is where the entire trade is done at one closing.
The more common exchange is a delayed exchange. The delayed exchange is when you sell the relinquished property first and later close on replacement property. This allows you to properly market the relinquished property and allows you time to pick a replacement property. The general guidelines in a delayed exchange are to identify replacement property within 45 days from the closing of the relinquished property, and to close on the replacement property within 180 days from the closing of the relinquished property.
Basically, you can identify up to three properties. You can close on one, two or all three so long as the other guidelines are met. The notification of the identified property is sent to your intermediary as per their guidelines and the 1031 tax code requirements.
Be sure to include language in the sales contract to sell the relinquished property for the buyer to agree to sign appropriate paperwork at the closing to affect the exchange. The following minimum language, if approved by your attorney should be in the purchase and sale agreement of the relinquished property and similar language in the contract for the replacement property or properties.
“The Purchaser or Seller as appropriate agree to participate in the paperwork for the other party to properly facilitate a 1031 Exchange. This contract is not contingent upon a 1031 exchange and the party doing the exchange hereby indemnifies the other party regarding said exchange. The contract is assignable to a 1031 intermediary for the specific purpose of said 1031 exchange”
There can be no debt relief in a fully deferred 1031 exchange. You must have again as much mortgage as you paid off. So if you when you close the relinquished property, you pay off a $5 million loan, your replacement property must have a total of at least $5 million in new or assumed mortgage.
The increased returns from exchanging versus not exchanging can be enormous. For a small tax due example, imagine if you sold a $1.5M property with a $500K loan and let’s say your tax bill is only $150K. On a non 1031 sale, after paying $150K in taxes you will have $850K to reinvest. But, if you do a 1031 exchange you are able to reinvest the full $1M boot. You are able to reinvest an additional $150K by doing a 1031 exchange. If the cash on cash return on the replacement property averages 10% per year over the next 5 years, the difference in just cash flow alone over the next 60 months is $75K. The larger property also offers added returns from the increased principal reduction, the increased appreciation from inflation and the larger profits when you eventually sell the more valuable property!
Want to build more wealth? Want to diversify your portfolio? Want to simplify your life? Want to be better prepared for retirement? Want to better prepare your estate for your loved ones? You’re invited to call us for an appointment. We will meet with you and carefully analyze your portfolio. Among other things we will look at the cash flows, expected appreciation, and the existing debt and returns on your current equity. We will look at your goals and your plans. Then we will help you determine strategies to add value to your endeavors. Depending on your mission, there are many goals where we might utilize 1031 exchanges.
* Would you like to increase your cash flow by exchanging high equity, no or low cash flow properties, into more cash flow producing properties?
* Want to build more wealth by trading from one property to two or more properties?
* Should you adjust your holdings geographically, or dissolve partnerships?
* Are you tired of management intensive properties and want to trade to stress free “mailbox money” properties?
* Should you diversify your holdings? Are you holding a lot of similar property types and want to reduce risk or increase appreciation by diversification?
* Should you trade some speculative properties to income properties?
We work with 1031 exchange buyers and sellers every day and have done so for decades. We would like to work with you. You will benefit from our proven “best practices” for effective and stress free exchanges. You will get more value from your relinquished property by utilizing our extensive buyer databases and the best marketing platform in the industry. You will have the best selection of replacement properties from our extensive ownership databases, access to every property search system known to man, and our team approach to locating property for 1031 clients. Here are a few of the best practices where we will add value to your 1031 exchanges.
* Start looking for replacement property at least by the first day your relinquished property goes under contract. Don’t wait until the closing.
* Engage a ELITE broker who specializes and is knowledgeable in your preferred property type early as possible, preferably before you start marketing your relinquished property.
* Make sure your broker has all the available property search systems, research systems, and property owner databases needed to effectively identify as many possible replacement properties as possible. ELITE Brokers have all the tools, resources, relationships, reputation and team members to provide and analyze more replacement property choices.
* Be sure your broker utilizes a team of ELITE brokers assisting in the search to insure you have a very large choice of replacement properties.
* In the beginning agree to an appointment with your ELITE broker at the same time, at least once a week, every week while you are looking for replacement property.
* Do not use the 45 day identification deadline period as your deadline to have property under contract. You should have completed as much due diligence as possible on under contract properties prior to the ID date.
* Understand the offer form or purchase and sale agreement you will most likely use when making offers. Do not wait until you find a suitable property to start an understanding of the most likely used offer format.
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