Section 1031 in the Internal Revenue Service is a boon for a prospective investor and allows for the selling of an investment property for profit by reinvesting in a similar property elsewhere in the country. This wonderful concept works on the principle of gain rolling from the old to the new.
There is widespread ignorance on the modalities about this exchange and as a result, 30-40 percent of property owners end up paying tax during the sale. A 1031 Exchange not only fructifies into essential tax savings but also makes possible the swapping of property in the fairest manner.
The 1031 Exchange excites the property market so much because the new income-generating replacement property gives the investor the double gain of added income and savings from the tax that would have otherwise gone to the IRS coffers. Also, besides saving the buyer from a huge tax burden coming in the guise of capital gains, the instrument offers maximum immunity and flexibility in reinvesting the money gained from the sale in a replacement property within a given period.
The exchange being time-bound is a critical aspect that has caused investors to stumble so it’s important to understand the role of the Qualified Intermediary. In every exchange of this kind, Qualified Intermediaries (QI) play a crucial role in connecting the buyer and seller. The Federal Tax Code makes the service of QI mandatory since 1991 in any exchange. The federal nature of the 1031 Exchange regulations makes the Qualified Intermediary’s job a complicated tactical and strategic endeavor as they are tasked with guiding and structuring the exchange, satisfying all parameters and suiting the goals of the clients. It is the QI who does the paperwork required by the IRS to document the exchange. The QI carefully prepares all documents and serves the parties with copies of the exchange agreement, novation agreement and escrow instructions.
The Exchange Agreement reads like a contract between the Exchanger and a Qualified Intermediary. The Exchanger explicitly agrees to transfer his old property to the Intermediary, in lieu of a new property to be supplied by the latter within 180 days. The contract outlines all terms and conditions under which the exchange of properties should take place.
For a 1031 Exchange to take effect, both the old property as well as the new property should be in the category of investment property, capable of generating income. Examples of this are rental property, bare land, vacation homes or more.
As soon as the old property is sold, within 45 days the seller has to come out with a list containing two or three probable properties fit for replacement. And the whole process of purchasing the new property or replacement property from the list must be over in a period of 180 days.
The exchange becomes bona-fide only when the title stays intact and whosoever held title to the old relinquished property gets the title of the new property.
In between the sale and purchase of property, the seller of the old property would get no access to the money he accrued from the sale, as the money will be vested with the ‘Qualified Intermediary’ till the exchange is completed.
This 1031 Exchange process has matured and had many names in the past including Like Kind Exchange, Deferred or Delayed Exchange, Simultaneous or Concurrent Exchange, Starker Trust or Exchange, Alderson Exchange, Reverse Exchange, Two, Three, or Four Party Exchange and Baird Exchange.
Hopefully, this will give you a little bit better of an understanding about this powerful strategy. If you want to learn more, go to LeafyLegalServices.com and sign up for our newsletter. You’ll be reminded when topics you are interested in are posted, when our Podcasts drop with our amazing guests (including 1031 Exchange experts) or if you have a specific question, just email us at email@example.com.