1031 Exchange - Overview

The Process

Selling the Relinquished Property: Before the close of the relinquished property it is necessary for the Taxpayer to contact a Qualified Intermediary to prepare the Exchange Agreement and contact the closing agent. Upon closing, the funds will go directly to the Qualified Intermediary and will be held over the course of the exchange. Protecting the exchange from actual or constructive receipt will therefore negate capital gains tax.

Identifying the Replacement Property: The Taxpayer has 45 calendar days, from close of the relinquished property to properly identify a replacement property. Your Qualified Intermediary will prepare all documentation necessary to officially identify the replacement property.

Purchasing the Replacement Property: The Taxpayer has 180 calendar days, from close of the relinquished property, to close on the “like-kind” replacement property. Your Qualified Intermediary will use the funds received from the relinquished property to purchase the replacement property.

BENEFITS

The benefits of a 1031 exchange are substantial. Investors defer capital gains taxation by exchanging their current property with a replacement property, giving them more buying power on their new investment. Benefits include:

1) Taxpayer’s ability to transfer the “earning power” of their tax dollars to another investment;

2) Management-intense properties can be sold and replaced with more manageable properties;

3) Equity from several properties can be consolidated into a single, more efficient property;

4) Property owners who move to a new geographic location can relocate their investments

Monetary Value of an Exchange

To understand the monetary benefits of an exchange, consider this example. An investor makes a sale for $600,000:

Calculate Net Adjusted Basis:
Original Purchase Price
Plus Capital Improvements
Minus Depreciation Taken
Equals Adjusted Basis
$400,000
$25,000
($175,000)
$250,000

Calculate Capital Gains:
Current Sales Price
Minus Closing Costs
Minus Adjusted Basis
Equals Capital Gains
$600,000
($30,000)
($250,000)
$320,000

Calculate Capital Gains Tax:
Recapture Deprecation
(25% x Depreciation Taken)

Plus Federal Capital Gains Tax
(15% x Capital Gains)

Plus State Capital Gains Tax
e.g. CA is 10% x Capital Gains

Total Capital Gains Tax Due
$43,750


$48,000


$32,000


$123,750

Instead of paying $123,750 in Capital Gains tax, the Taxpayer can use these funds to purchase replacement property through a 1031 Tax Deferred Exchange.

Disclosure Note: This information is subject to interpretation and meant to help the consumer understand information surrounding a transactional nature for 1031 exchange. It is important to seek specific and individual guidance and information from you financial advisor. This information is merely an overview and is not intended to be exhaustive. Consult with your tax advisor to determine whether an exchange is appropriate for your circumstances.