Frequently Asked Questions from our Valued Customers:
What is a tax-deferred exchange?
A tax-deferred exchange is a process that allows taxpayers to exchange their investment or business property while deferring the payment of capital gains tax. Typically, there is a time gap between the sale of the relinquished property and the acquisition of the replacement property.
What authorizes a deferred exchange?
In June 1991, IRS regulation 1.1031(k) provided specific guidance to implement the “Starker” case decisions, which had been used for exchanges for many years. This regulation was based on the Internal Revenue Code section 1031 passed in 1986.
How did the Tax Reform Bill of 2018 affect 1031 exchanges?
Thanks to the hard work of the Federation of Exchange Accommodators (FEA) and its members, real property exchanges, such as real estate, were retained in the Tax Reform Bill of 2018. However, personal property (equipment, trucks, art) and intangibles (franchise rights, collectibles) were eliminated from the 1031 exchange.
What are the criteria for a deferred exchange?
To qualify for a deferred exchange, the properties involved must be of like-kind. This means that the property being relinquished must currently be used as an investment or business property, regardless of the buyer’s intended use. The replacement property must also be used by the exchanger as an investment or business property. Like-kind properties can include townhouse rentals, land, farms, office condos, warehouses, vacation rentals, and more.
How are capital gains calculated?
The potential capital gains that can be deferred in a tax-deferred exchange are determined by adding the profit from the sale of the relinquished property to all the depreciation taken on that property.
What are the reinvestment requirements in an exchange?
For the exchange to be completely tax-free, the acquisition cost of the replacement property must be equal to or greater than the adjusted sale price of the relinquished property. The total cash equity from the relinquished property must be held in a qualified escrow account and reinvested in the replacement property. Any cash not reinvested, known as “cash boot,” is subject to capital gains tax. Additionally, the replacement property must have mortgage debt or new cash added, equal to or greater than the mortgage paid off or assumed on the relinquished property.
How is the replacement property identified?
Typically, up to three potential replacement properties are identified by their address or legal description. The identification must be in writing, signed by the exchanger, and delivered to the qualified intermediary.
How are the exchange escrow funds controlled and secured?
The qualified intermediary is responsible for controlling the funds in a tax-deferred exchange. The exchanger has no right to receive, pledge, borrow, or benefit from the cash held in the escrow account. Qualified intermediaries only hold funds in federally insured accounts to ensure their security.
Are there special rules for a qualified intermediary?
The qualified intermediary should be an experienced real estate professional who understands all aspects of the exchange and contract process. IRS regulations specifically exclude the exchanger’s agent, broker, attorney, accountant, most family members, and others with a business relationship with the exchanger from serving as the qualified intermediary.
What is the first step in conducting a deferred exchange?
Representatives or investors should contact a qualified intermediary to discuss the proposed exchange and obtain the necessary contract addendum for the property being relinquished. An exchange agreement must be signed by both the exchanger and the qualified intermediary before the settlement of the first relinquished property.
What is the role of the qualified intermediary?