Many investors have found real estate to be an attractive vehicle to protect and grow their investment. Sometimes, an investor may wish to sell one piece of real estate and immediately invest in another. When this happens, investors need to be able to sell one property and purchase another without incurring the capital gains and depreciation recapture tax liability. To do so, many investors use a 1031 Exchange.
The 1031 Exchange is so called for the section of the IRS code which authorizes and gives the requirements for such a transaction. In simple terms, it allows an investor to exchange one investment property for another while continuing to defer the capital gains and depreciation recapture tax liability. To take advantage of this tax deferment, an exchange must meet all of the requirements stated in section 1031.
First, the investor needs to identify a Qualified Intermediary to facilitate the exchange. The Intermediary will take and hold the proceeds from the sold property until they are re-invested in the acquired property. The agreement with the Intermediary must be written to ensure the investor does not have constructive receipt of the funds.
Second the investor must identify the replacement property. The replacement property must be of “like-kind” as the property sold. However, this requirement is liberally construed and most any type of real property will qualify. Investments into REITs, real estate funds, and other securities do not qualify.
The acquired property must be identified in writing within 45 days and closed on within 180 days of the closing of the sold property. Investors do have some leeway in identifying replacement properties. The replacement property must only fit one of the following three rules:
- 95% Rule; Identify any number of properties, regardless of value, as long as least 95% of the properties are ultimately acquired.
- 200% Rule; Identify any number of properties as long as the combined fair market value is not more than 200% of the fair market value of the sold property.
- 3 Property Rule; Identify up to 3 properties regardless of value.
Among the most important to note of the remaining requirements is that the acquired property must have a fair market value greater than or equal to the fair market value of the sold property. The property must be held for business use or investment, and all net profits from the sold property must be used for the purchase of the acquired property.
Whether it’s investing in a 1031 Exchange or investing in your family’s dream home, Boatman Ricci and Trinity Title are here to serve you. Our attorneys have the knowledge, skill, and experience to serve all of your real estate needs.
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