Why exchange Investment properties ?

 First, of course, you save taxes immediately  requiring no upfront fees and maintaining a low final cost ensuring a cost-effective solution for clients. Second, while 1031 Exchange strategies have been grounded in the IRC since 1921, our attorney expertise and approach offer modern solutions to this longstanding strategy. As a third benefit, we deliver strategic options designed to help real estate investors optimize their portfolios for lasting financial success. Diversifying across different markets or asset types can help investors reduce the risks associated with concentrated holdings. For those managing multiple properties, consolidation through a 1031 exchange can help alleviate the administrative and maintenance burdens, offering management relief and an improved quality of life. Investors can also build a portfolio by leveraging pre-tax dollars to expand their holdings, utilizing the increased purchasing power to acquire higher-value properties. Additionally, a 1031 exchange can facilitate relocation for retirement, job changes, or more favorable market conditions. It allows investors to improve cash flow by transitioning built-up equity into better-performing assets, while deferring tax consequences.

Diversification: By market or by asset type: Owning real estate concentrated in a single market or geographic area or owning several investments of the same asset type can sometimes be risky. A 1031 exchange can be utilized to diversify over different markets or asset types, effectively reducing potential risk.

Consolidation: Investors who own several different properties can bear the burden of administrative and maintenance responsibility. Considerations: How many different potential liabilities – roofs, windows, boilers, and other items is the investor responsible for maintaining? How far apart/away from home are these properties? Does the employment of management companies diminish returns?

Management Relief/Quality of Life: How much is the investor’s time worth? Similar to the logic behind consolidating, even owning one large rental property with several units can be management intensive. After years of being a landlord, many multifamily owners get sick of the “Four Ts”: tenants, toilets, termites, and trash. Many of these investors utilize the 1031 exchange to acquire replacement properties subject to a long-term net-lease under which the tenants are responsible for all or most of the maintenance responsibilities, there is a predictable and consistent rental cash flow, and potential for equity growth.

Build a Portfolio/Leverage up: In a 1031 exchange, pre-tax dollars are used to purchase replacement real estate. This provides the exchanger the ability to purchase replacement property with funds that would have otherwise been paid as capital gains tax on a sale of the property. The exchanger can potentially leverage such funds to substantially increase their purchasing power and wealth building potential. More equity can lead to a lower loan to value ratio and approval on the acquisition of a higher value property. As a long-term strategy, a 1031 exchange can be repeated indefinitely and combined with other tax strategies to build a portfolio.

Better Location: An investor could move their investments to a different national location for a variety of reasons that might include: retiring to another state; job relocation; more favorable market & lower taxes; and many business incentives.

Cash Flow: An investor can utilize an exchange to transition built up equity to a better performing asset without realizing the tax consequences of the sale.

Estate Planning: Currently, it is possible to exchange like kind real estate indefinitely over a lifetime, continually deferring capital gain and transferring basis to each subsequent property until the taxpayer’s death. The subsequent heirs who inherit real estate, whether it has been part of a §1031 exchange or not, receive the “stepped-up” basis which is generally defined as the fair market value of the inherited property at the time of death. In this fashion, significant capital gains liability can be eliminated permanently with proper planning. In a nutshell, all the built-in gain on the replacement property, which transferred from the relinquished property goes away upon the death of the taxpayer. Also, utilizing an exchange, an investor can potentially sell and divide a large property into several smaller properties, one for each of their heirs, while minimizing capital gains tax.

An IRC §1031 tax deferred exchange allows owners of real estate to defer the recognition of a capital gains tax they would normally recognize when they sold their property. Exchanging allows investors to reinvest money into new business or investment real estate that would otherwise have been paid to the government as a capital gains tax. Tax deferred exchanges are not new – they have been available in one form or another since 1921, and in its current format since 1986.

Simply put, an exchange is structured as a sale, just like any other sale, and a purchase just like any other purchase, but with the inclusion of a Qualified Intermediary to structure the transaction as an exchange. Instead of paying a capital gains tax, an exchange enables an investor to use that money toward the purchase of a new property. In order to obtain this benefit, it is important to involve a Qualified Intermediary before you start your transaction, and to comply with the Tax Code’s requirements throughout the transaction.

We Work Fast! It is never too early or late to contact us to discuss the benefits of a 1031 Exchange -- Exchangers are encouraged to call or email our office with any questions. (813) 405-4179

One of the most misunderstood concepts of tax deferred exchanges is the requirement to exchange “like-kind” real estate. Many people mistakenly believe that “like-kind” means that you must acquire the same type of real estate that was sold in order to complete an exchange. Nothing could be further from the truth. Exchangers can sell one type of real estate and buy an entirely different type of real estate. In order to qualify as “like-kind,” the real estate must be held for productive use in a trade or business, or for investment purposes. Real estate held primarily for resale purposes (flips, held for a year or less, or as inventory) or for personal use is generally disallowed. Most real estate that produces rental income is generally eligible regardless of the type. Real estate that is part primary residence and part rental property can generally qualify in part.

What this means is that Exchangers have the opportunity to purchase replacement real estate of any type. For example, an Exchanger can sell vacant land and buy a strip mall or sell an apartment building and buy a triple-net lease property. 1031 Exchangers can look to a combination of federal and state law to help determine if an asset is real estate for purpose of the like-kind requirement. Based on this guidance, the definition of “real property” for 1031 purposes is very broad and generous to investors. Therefore, it may be possible to exchange real estate interests such as air rights, easements, tenant-in-common interests, options, leases, conservation easements, oil and mineral rights, and development rights for similar rights or even for more traditional rights like fee interests in real estate. The below graphic illustrates how all real estate held for business or investment purposes is “like-kind” to all other real estate held for business or investment purposes.

Investment Counsel Exchange, LLC is an attorney owned & operated client-centric consulting firm operating with the highest ethics, character and financial protection. 

We consult, train, and operate as a Qualified Intermediary for IRC §1031 tax deferred exchanges. A Qualified Intermediary is a necessary independent third party to the transaction whose function is to structure the exchange, as well as to act as the independent escrow agent for the exchange funds. 

Investment Counsel Exchange, LLC prides itself on providing the support and information you need to complete your 1031 exchange transaction. Our experience enables us to handle many different types of exchanges (below). I.C.E. is committed to giving personalized service to every client, but especially those who are new to 1031 exchanges. We are experts.

Investment Counsel Exchange, LLC takes multiple steps to provide the utmost security for your exchange funds including the use of a fidelity bond and segregated dual signature escrow accounts.  Exchange funds are never “invested” as with some other qualified intermediaries – Investment Counsel Exchange, LLC only deposits exchange funds in money market or savings accounts as principal retention is of the utmost importance.

• Delayed, Forward and Simultaneous Exchange Structures
• Reverse and Build to Suit - Parking Exchanges
• Segregated Escrow Accounts for each Exchange
• Dual-signature Escrow Accounts
• Fidelity Bond for Unsurpassed Security of Exchange Funds
• Unparalleled Expertise and Customer Service
• Member of the Federation of Exchange Accommodators
• Accredited Continuing Education Courses for Attorneys, CPAs, Realtors, & other Professionals
• Attorneys on Staff

A Qualified Intermediary, or QI, is an independent third party to the transaction whose function is to prepare the documents necessary to create the exchange, as well as to act as the independent escrow agent for the exchange funds. 

Investment Counsel Exchange, LLC is a great resource for information on §1031 exchanges. However, as a qualified intermediary we are unable to give tax or legal advice to exchangers. Therefore, it is important to have a tax and/or legal advisor who can work with Investment Counsel Exchange, LLC to give you the advice you may need. Retaining an attorney or accountant is not mandatory to complete an exchange, but it is recommended.

Although it is not a requirement, it is good practice to modify your contract or purchase and sale agreement to reflect your §1031 exchange transaction. This language is commonly known as the “exchange cooperation clause”.

In addition to holding the exchange funds, a QI’s role is to prepare the §1031 exchange documents that will convert your transaction into an exchange. Without §1031 documents your sale will most likely be a taxable event even though you reinvest the funds in a new property. Investment Counsel Exchange, LLC will ask you to send a copy of your relinquished contract or purchase and sale agreement and use the information in the contract to prepare the exchange documents. In order to have a valid exchange the QI must assign into your purchase agreement. These documents must be prepared before you sell your relinquished (sale) property.

Since exchangers only have 45 days from the date of the sale of their first relinquished (sale) property to find their new replacement property, it is often good practice to begin looking before your first sale takes place. The 45 day identification period does not begin to run until the actual sale of the first relinquished (sale) property, and not the contract signing date. You may enter into a contract to purchase before you sell, you may “identify” properties that you may like to purchase, but you may not make an official §1031 identification until you have sold at least one of your relinquished properties.

Once the exchange documents have been prepared by the qualified intermediary, a closing can be scheduled to sell the property just like any other closing. It is important to remember that after closing costs and any debts have been paid, the net proceeds from the sale must come directly to the qualified intermediary, unless you are structuring your transaction as a partially deferred exchange. Your attorney, or any other disqualified party, may not take control of the proceeds from the closing before sending them to the qualified intermediary.

In order to have a fully tax deferred exchange an exchanger must: 1. buy for as much as it sold for; 2. utilize all of the cash proceeds received from the sale to purchase the replacement property; 3. obtain as much financing on the replacement property as was paid off on the relinquished property or replace all of the debt with new cash if not financing; and 4. obtain nothing but like kind property when purchasing the replacement property. If an exchanger violates any or all of these rules, then the taxpayer may still have a valid exchange but will recognize some capital gains tax. 

The exchanger must identify potential replacement property by midnight of the 45th day from the sale of the first relinquished property. Investment Counsel Exchange, LLC provides a form to identify property with each set of exchange documentation. This form must be filled out and sent to Investment Counsel Exchange, LLC by email, fax or mail. For more information please see our article on How to Identify Replacement Property.

Once the exchanger has decided on the replacement property or properties to be purchased, a contract to purchase the properties must be entered into. As a matter of practice these contracts should also have the exchange cooperation language added to them.

With very limited exception the tax ID number or social security number of the selling person or entity must be the same number when that person or entity is purchasing the replacement property. An exchanger may not sell as an individual and buy in as a corporation even if that individual owns 100% of the new entity. Exchangers may sell and purchase as tenants in common, or, in certain circumstances, in new entities such as single member limited liability companies or a Delaware Statutory Trust (DST). If the exchanging person or entity is not the same on both sides of the transaction, please check with your tax or legal advisor before continuing the exchange.

Once the exchanger has entered into a contract or purchase and sale agreement to purchase the replacement property or properties those contracts should be forwarded to the QI so that it can prepare the replacement property exchange documents. In order to make the purchase the QI must assign into the transaction.

In addition to the documents that must be prepared for the closing, the qualified intermediary will need to send the exchange funds that it is holding from the sale property to make the purchase of the replacement property. Remember to notify Investment Counsel Exchange, LLC at least a day in advance of your closing to request the exchange funds to make your purchase. Investment Counsel Exchange, LLC can arrange for a wire transfer of the exchange funds or a bank check to make the purchase. 

Common Question #1:  Is a 1031 only for Federal Capital Gains Taxes?

No. . . Section 1031 applies to federal capital gains taxes (15% or 20%), & also Depreciation Tax (25%), & Medicare Tax (0% or 3.8%), & State Income Taxes (up to 21.3% in some states). Long-term capital gains taxes apply to property held over 1 year – gains from property held less than a year are typically taxed as ordinary income. 

OWNER CARRIED FINANCING  

If a seller carries back a note on their sale property, the IRS will treat this note as taxable, upon each installment received by the seller. Generally, under the installment method, the principal portion of each payment is subject to capital gains tax and the interest portion is subject to ordinary income tax, in the tax-year they are received. How can a seller include a note in the exchange and defer capital gains taxes indefinitely?

First, the note should be payable to the EA (“Exchange Accommodator”) which puts the note in the exchange. The note must first be converted to cash before the exchanger can buy the new property. How does an exchange convert the note into cash?

There are three ways:

1. The exchanger buys the note from the EA for face value and the EA assigns the note back to the exchanger. Because the exchanger bought the note from the EA at face value, as they receive the principal payments, the payments are treated as a tax-free return of basis. The exchanger will pay income tax on the interest on the note as they receive it, but the principal payments are tax free. Meanwhile, in the exchange account the EA is holding the cash that the exchanger can now use to purchase the new property.
2. Find someone to buy the note. Unfortunately, because the note is unseasoned (i.e., is a brand-new note) a potential buyer of that note would demand a large discount.
3. Get the seller of the new property to agree to take the note as part of the purchase of the new property. As a practical matter, this rarely happens.

Vacation homes have long been a source of angst among exchangers and their advisors because of the lack of guidance on whether they qualify as an investment property for IRC §1031 purposes. In the past, exchangers readily exchanged “second homes” based on the claim that in addition to enjoying the vacation home personally they also purchased the property as an investment, and thus, it would qualify as a 1031 exchange.

However, taxpayers may want to rethink their position on any such exchanges. In May 2007, the Tax Court issued an adverse ruling, disqualifying the exchange of a vacation home in Moore v. Commissioner (T.C. Memo. 2007-134). In its analysis, the court agreed with the Service that the taxpayer’s primary intent of ownership for the properties was for personal use, not investment, and thus denied the exchange.

While the Moore ruling seemed to close the door on the matter, the Service released Revenue Procedure 2008-16 to provide some additional guidance and restrictions. While most of the Rev. Proc. appears to be influenced by the Moore ruling there have been some changes. The Rev. Proc. defines the “qualifying use standards” of a relinquished property dwelling unit as: a) the dwelling unit is owned by the taxpayer for at least 24 months immediately before the exchange (defined as the “qualifying use period”); and b) within the qualifying use period, in each of the two 12-month periods immediately preceding the exchange, (i) the taxpayer rents the dwelling unit to another person or persons at a fair rental for 14 days or more, and (ii) the period of the taxpayer’s personal use of the dwelling unit does not exceed the greater of 14 days or 10% of the number of days during the 12-month period that the dwelling unit is rental at a fair rental. The rules for the purchase of a replacement property mimic the rules for a relinquished property, except that the qualifying activities are prospective.

Furthermore, the Rev. Proc. suggests that a taxpayer purchasing a replacement property expecting to meet the qualifications, but in actuality does not, “if necessary, should file an amended return and not report the transaction as an exchange.”

This revenue procedure provides a safe harbor under which the IRS will not challenge whether a dwelling unit qualifies as property held for productive use in a trade or business or for investment under Section 1031. It is just a safe harbor. An exchange may still fall outside the parameters and meet the statutory requirements, but you should expect heightened scrutiny in such a case. The safe harbor is effective for exchanges occurring on or after March 10, 2008.