1031 Tax Deferred Exchange basics: Stringent rules and timetables that must be complied with

The sale of real estate held for more than 12 months triggers capital gains taxes on the net profits of that sale. These taxes may be deferred by participating in a 1031 Tax Exchange, in essence, by purchasing property(s) to replace the one(s) being sold. However there are stringent rules and timetables that must be complied with. This applies to the sale of commercial or investment property, but not your personal residence. The entity that conducts the 1031 Exchange is known as a qualified intermediary (QI). The IRS requires that a "third party" conducts the exchange so the QI will act as a principal in the transaction. A few interesting points about qualified intermediaries (QI). Currently there are no licensing requirements. QI cannot be the taxpayer. The taxpayer's accountant, attorney and real estate agent, who worked with the taxpayer during the prior two years, are disqualified from serving as the QI. Qualified Properties: Replacement property acquired in an exchange must be like kind to the property being relinquished. Like kind means "similar in nature or character, notwithstanding differences in grade or quality." Both the relinquished and the replacement properties must be held by the exchanger for investment purposes or for "productive use in their trade or business." Personal property is not eligible for exchange. General Rules: Identify the replacement property within 45 days after transfer of the relinquished property. Receive title to the replacement property within 180 days after the transfer of the relinquished property. All proceeds of the sale of the relinquished property must be held by a third party, a "qualified intermediary." All cash proceeds must be invested to fully defer taxable gain. Full and Partial Exchanges When all the proceeds of the sale are used to purchase a replacement property and the value, equity and debt are all "equal to or greater than" a full deferral of the capital gains tax is possible. If all these rules are not complied with a partial deferral of the taxes may be possible. "Boot" - A term used to describe other non-qualified property received in an exchange, that is not like kind to the property acquired. (cash, stock, personal property) The "boot" proceeds in the exchange are considered a gain and are taxable. As one can see 1031 Tax Deferred Exchanges can be very beneficial but they are complicated with many rules (only some of which we have examined in this article). There are many different types of exchanges and clients need to speak with a specialist, a qualified intermediary. Edward Smith, RECS, is the Long Island metro regional director of Coldwell Banker Commercial NRT, Eastport, N.Y.