Fundamentals of a 1031 Exchange


Do you own a piece of property that has increased in value? Is it your intent to sell it in order to invest in another piece of property? If so, think again. A sizable amount of the profit you realize on the sale could very well disappear to the IRS in capital gains tax. That means less money to invest in your new venture. One alternative that may allow you to avoid the capital gain tax is an IRC1031 Exchange.

A 1031 Exchange refers to IRS Code Section 1031. This Code Section outlines rules that allow you to exchange one piece of property for another "like-kind" property. Thus, allowing you to defer the tax that would otherwise be payable.

A simultaneous exchange takes place when you trade your property for property another party already owns. The reality is however, that simultaneous exchanges are extremely rare. Therefore, for the taxpayer's benefit, the tax laws allow for a "deferred exchange," wherein various buyers and sellers can come together to complete a valid IRC 1031 Exchange.

A deferred exchange is one in which you transfer your property to a qualified intermediary, which in turn sells your "exchange" property and purchases the "replacement" property on your behalf. This process restricts the taxpayer from having access to the funds, but allows the transaction to receive treatment under IRC 1031.

To Qualify for the "Like-Kind" Treatment and a Qualifying IRC 1031 Deferred Exchange, Five Conditions Must be Met:
1. You must hold both the property traded and received for business or investment purposes.
2. The property traded and received must not be held primarily for sale, such as inventory.
3. The properties must be tangible. For example, they cannot be stocks, bonds, notes, securities, evidences of debt, or partnership interests.
4. The properties must be of like kind, e.g. real estate for real estate.
5. Two timing rules must be satisfied in a deferred exchange.

Timing Rules
First, a taxpayer has 45 days from the transfer of the "exchange" property to make written identification of the "replacement" property the taxpayer wants to receive. Second, the taxpayer must receive the "replacement" property by the earlier of 180 days after the transfer of the "exchange" property or the due date of the tax return for the year of transfer.

Planning and Accounting for an IRC 1031 Exchange
It is critical that taxpayers involved in an IRC 1031 Exchange get the proper consultation before, during and after the exchange process. For example, your tax consultant should inform you regarding the current tax law and whether or not your transaction qualifies under Code Section 1031. Moreover, the consultant should analyze your tax liability and any potential tax savings, prepare the necessary tax forms to report the transaction and ensure that the overall exchange qualifies under IRC Section 1031. A qualified intermediary does not perform these services, but is responsible for preparing the specific exchange documents for the escrow company at closing.

Qualified Intermediaries
As a service to our clients, Kyler Kohler & Ostermiller, LLP has associated with a qualified intermediary: Intermountain Exchange, LLC. This affiliation helps in allowing for a smooth handling of all of the transactions involved with the exchange. (Separate fees for Intermountain Exchange's services will apply).

For additional information please go to: www.intermountainexchange.com
856 South Sage Drive, Suite 300 Cedar City, Utah 84720      Phone: (435) 586-9366      Fax: (435) 586-9491

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