TAX DEFERRED EXCHANGES
Courtesy of Dan & Patty McInnes
TAX DEFERRED EXCHANGES
Courtesy of Dan & Patty McInnes
CONSULT YOUR TAX ADVISOR FOR ANY
SPECIFIC TAX ADVICE AND
FOR DETAILS ON EACH OF THESE ISSUES AS IT EFFECTS YOUR SITUATION.
The latest news about exchanges is that the IRS now allows Reverse Starker exchanges or Reverse 1031 exchanges. This means that you can buy the replacement property first and then sell the exchange property. The article below is an overview to highlight the different types of tax deferred exchanges that are possible in light of the newest IRS rulings. It is not intended as a full discussion of all the aspects of exchanging. It is intended as a simple non-technical explanation which can serve as a starting point for you to discuss your tax situation with your tax advisor. It is essential that you consult with your tax advisor before entering into any transaction concerning any 1031 exchange or reverse exchange. The process is complex and must be executed properly or the tax deferral may be disallowed. It is also very important to work with an experienced Realtor and escrow company so that the process will be done properly.
Regular 1031 Exchange First, here is a brief and simplified explanation of a "normal" 1031 tax deferred exchange. A rental or investment property is sold and another investment property is purchased using an exchange methodology through which the seller does not receive any monies or control of the monies during the transaction. Generally, the seller receives no cash from the transaction. If the process is done correctly, the IRS allows the seller to trade one property for another without paying taxes on the capital gain. The taxes are deferred until a later time. The taxes are deferred to a point in the future when the last property in the series of exchanges is sold and then the tax payer pays on the gain that has built up over time. This gain is adjusted in various ways such as credits for capital improvements (major improvements) to the properties over time. There are many rules for adjusting these calculations and we recommend again that you consult your tax advisor so that you are aware of the credits and debits involved in the calculations. The purpose of exchanging properties is to put off the tax consequences until a time that the seller wants to receive the cash, often when the tax payer is in a lower tax bracket after retirement. The 1031 exchange is obviously a benefit when owning and selling rental/investment property. Investment property can be any property held for investment. For example, investment or 1031 property may be vacant land, apartment building, a condo that is rented or any other investment property. This type of property is distinguished from your principal residence or second home properties.
Delayed Exchange A basic 1031 exchange occurs when the seller puts his first property into escrow, then finds the second property that he wants to buy, enters into escrow on this second property and the two escrows close on the same day. The problem arises when the two cannot close at the same time or the seller cannot find the property to exchange into right away. A famous tax court case involving T. J. Starker has led to a modified 1031 exchange in which the seller closes escrow on the first property, puts the proceeds into an "accommodator account" which is held by a neutral party so that the money is never received by the seller, and later the replacement property is found and purchased. The IRS ruled that this type of exchange is allowable with certain rules. These include that the replacement property must be identified within 45 days of closing the first property and the replacement property must close escrow within 180 days of the closing on the first (exchange) property. There are other rules and regulations concerning the accommodator, timing, number of properties that can be named and so on.
REVERSE STARKER EXCHANGES The IRS has recently issued the "safe harbor" rules to allow another option in exchanges. Now the seller can buy the replacement property first and then sell the first property. This new method is complex and, again, the rules must be followed carefully. The new property is transferred temporarily to an independent third party "accommodator" who takes title to the property. This is called "parking" the property. When the old property is in escrow, it also goes to the accommodator who then exchanges the property, acting like a middle man in the transaction. The agreement with the exchange accommodator must be in writing and the contract must state that this specific type of exchange will be performed by the taxpayer. Parties involved as in all exchange transactions, must be unrelated to each other. As in the delayed exchange there are time limits. The property to be sold or "old" property must be identified within 45 days and the whole exchange must be completed within 180 days. There are more complex considerations for the accommodator in this situation since the accommodator has legal title to the property, and is not just acting like an escrow company holding monies. For example, if there are problems with the property during this period of "ownership" the accommodator would want to be indemnified. This new type of exchange involves new issues and this is only a brief summary of the transaction to outline the concept. Please consult your tax advisor for full details. The IRS Bulletin 2000-40 is available on the web at www.irs.gov. This summary is based on an article by Robert J. Bruss published in the fall of 2000 in the
CALIFORNIA REAL ESTATE LAW NEWSLETTER. Call us at Scott-McInnes Realtors for more information from the Robert Bruss article, 805-985-4949.
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Dan
and Patty McInnes Scott-McInnes & Company, Realtors 3600S. Harbor Blvd., #129 Oxnard, CA 93035 TOLL FREE - 1(800) 985-VIEW (805) 985-4949 Fax (805) 985-9552 |
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