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To Exchange or Not to Exchange, that is the question!
Whether ‘tis better to sell and pay taxes or by deferring gain to leverage your portfolio?
Section 1031 of the Internal Revenue Code provides that neither gain nor loss is recognized if property held for investment use in trade or business is exchanged for like property. The term “like kind” refers to the grade or quality of the property, not a specific type or class. Thus, single family rentals can be exchanged for a retail strip center, commercial or industrial property.
The Delayed Exchange is the most commonly utilized strategy, validated by the 1979 federal case, Starker v. U.S. 602 F2d 1341, 9th Circuit. The seller retains a Qualified Intermediary to facilitate the exchange so that the Seller never has actual or constructive receipt of the funds. The Seller has 45 calendar days from the date of sale of the relinquished property to identify an exchange property and 180 days to close on the replacement property.
There are very specific rules as to documentation, designation, and delivery and so it is very important to have confidence in the Qualified Intermediary handling your transaction. You will need to focus all you attention on finding the exchange property which presents various challenges in any market. You have three options for identification during the 45 days:
- Select three properties, regardless of fair market value.
- Pick any number of properties, provided that the aggregate fair market value does not exceed 200% of the fair market value of all the relinquished properties.
- Any number of properties may be selected with no restriction on value, provided that you acquire 95% of the value of the identified properties.
The Reverse Exchange is less stressful but less stress comes at a price. The Seller acquires the replacement property prior to the sale of the relinquished property, utilizing an Exchange Accommodation Titleholder to hold title until the Seller has sold the relinquished property. The 180 day rule applies as with the delayed exchange and there are various requirements and additional insurance complicating the Title Parking process.
The Simultaneous Exchange, Improvement Exchange, and Personal Property Exchange are addressed as well under IRC § 1031 and the best time to evaluate these options is during the evaluation process.
Explore all options with your Realtor and once you have made the decision to exchange, there’s no shortage of experienced Qualified Intermediaries to explain in further detail what you can expect and how much the tax savings will cost.
Relevant links:
http://www.orexco1031.com/
http://www.ipx1031.com/
http://apiexchange.com/
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