YOU Magazine - September 2006 - 1031 Exchange Deferring Taxes Through Real Estate
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Kathleen Petty     Kathleen Petty
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Global Credit Union Home Loans AK#157293
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1031 Exchange
Deferring Taxes Through Real Estate


1031 Exchange - Deferring Taxes Through Real Estate

Invest your money, watch it grow, and then sell off the investment. It sounds like a great idea... until you write a big check to the IRS on the gain. Seems inevitable, right? While in most situations this may be true, it's not the case for certain types of real estate transactions.

Real estate has proven itself to be not only a profitable investment but a reliable one as well. For anyone who's taken advantage of these gains over the last few years (and will be selling their investment property soon), it would be easy to imagine that Uncle Sam is rubbing his hands together in anticipation of the tax receipts. Given that scenario, why would anyone choose to invest in real estate in the first place?

Let's examine the issue more closely. In the book, The Millionaire Real Estate Investor, it states that real estate not only appreciates, it can be rented, improved, and even leveraged. Keeping that in mind, let's say you want to cash in on an investment property's equity but don't necessarily want out of the real estate game. Did you know that if you re-invest the gains from said property and roll them into a new property you may have the ability to defer the taxes till a later date?

The IRS allows for deferred taxation on certain types of investment real estate through what is known as a 1031 Exchange. Simply by choosing to re-invest all of the realized gains into a property of "like-kind", you can defer paying taxes until a later date of your choosing. (Please note that you must also take on a new mortgage of equal or greater value to the one you are paying off.)

Dave Jenks, co-author of the aforementioned book, adds that the government wants you to invest in property. To demonstrate, he sums it up with what he calls the "Three Ds": Depreciable, Deductible, and Deferrable. The government encourages you to invest by making these vehicles available to you. Jenks goes on to say that Millionaire Real Estate Investors "believe taxes deferred until tomorrow are always better than taxes paid today."

The IRS, on the other hand, sums it up this way. "No gain or loss shall be recognized if property held for productive use in a trade, or business, or for investment is exchanged solely for property of like-kind."

In order to complete a 1031 Exchange, the process (albeit simple) has some very specific guidelines. First, the property needs to qualify as being "like-kind". This does not mean an investor has to swap one property for an exact duplicate of the one they are selling. For example, if you own a single family rental home, you don't have to buy another single family home to get the benefits of a 1031 Exchange.

It does mean, however, that the property being sold must be for investment, and you have to purchase another property for the same purpose. Using the sale of a single family rental home as an example, this could mean buying a duplex, an apartment building, a commercial property, raw land, or even multiple properties in exchange. What you cannot do is sell real estate and re-invest the proceeds in stocks, a business, bonds, or other items that are not "like-kind" according to the IRS.

In order to qualify for the tax deferment, you also need to use a Qualified Intermediary, a third party whom you identify at the time of your property's sale. This Qualified Intermediary will need to be identified on both the purchase agreements of the property you are selling and purchasing. This is highly important as it forms a paper trail, satisfying the IRS in case of an audit.

At the time of sale for the property you own, an assignment of your interests will be granted to the intermediary who will hold these proceeds until you purchase your next property. The proceeds will then be applied at the time you take possession of the property you are buying.

The timing to make a 1031 Exchange is also very important for the IRS. At the time of sale, you have up to 45 days to identify the next property you are purchasing. It's important to know you can choose multiple properties within this timeframe in the event you can't come to terms on a specific one. Ultimately, however, you do have to buy one (or more) of the properties from the list. In order to successfully complete the 1031 exchange, you are also required to finalize the purchase of the next property within 180 days of the sale of the property you are exchanging.

Be advised, the selection of the proper mortgage program for any real estate investment purchase as well as the price points of both properties are critical to the profitability of the venture. As mortgage programs change continuously, depending upon secondary market conditions and appetite, direction from a mortgage professional is advisable as soon as you decide to sell one property in exchange for buying another.

If you would like to know more about 1031 Exchanges, contact the professional who supplied you with your copy of YOU Magazine. Ask for your free copy of an interview with Craig Procter, Vice President of Starker Services, the oldest and largest independently owned Qualified Intermediary company in the country.

Good luck on making money... and deferring your taxes!


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