Tag Archives: Internal Revenue Service

Some Important Reminders About USC Section 1031

Businesses rely on investments and assets in order to survive, although there are times when some of these go so bad that it’s time to have them removed. However, rather than go through the trouble of liquidating them and buying a new one, savvy businessmen can simply swap their old assets with new ones, and pay little for the transaction. This is known as real estate exchange.

Section 1031 of the Internal Revenue Code deals with the “exchange of property held for productive use or investment”. While this description sounds pretty straightforward, this does give some limits to 1031; it can’t be invoked to swap one residential property for another, unless it’ll be used for investment (rather than living) purposes. The term “property”, however, is very broad and can include even small things like cars and paintings.

According to the Internal Revenue Service (IRS), up to three of these properties can be designated as replacement properties, provided that the buyer makes a transaction on at least one of them. In addition to that, taxes can still apply on exchanges that involve properties with existing debts and mortgages, like office spaces. This is especially true if, say, the old property has a greater mortgage than the new one because this will mean that the buyer only has to pay off a smaller mortgage after the exchange, which is considered by the IRS as “income”.

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Pulling off a Delayed 1031 Exchange

Delayed exchanges under Section 1031 are highly popular among investors. As the name implies, there’s a time delay between the investor relinquishing their property and buying a second one. If you are considering a delayed 1031 exchange but don’t really know how to crack it, here are the steps.

The property owner seeking an exchange on his asset should first acquire a Qualified Intermediary. The party will facilitate the sale by drafting up an exchange agreement and tasking the closing agent to complete procedures on their end. The property will be directly-deeded to the buyer, but the proceeds will be temporarily held up until the owner of the now-relinquished property finds a replacement property no later than 45 days after the close.

For the identification, the exchanger will need to abide by certain rules. The Three-Property Rule allows them to pick three open properties regardless of fair market value. The 200 Percent Rule takes into account any number of properties whose aggregate fair market value shouldn’t be equal to twice their fair market value. The 95 Percent Rule applies to any number of properties regardless of fair market value as long as the person acquires 95% of the properties’ value. The replacement property itself should be secured within 180 days.