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At Layman & Nichols, we often work with clients on tax deferred exchanges. In this video, Mac Nichols talks about the benefits of a 1031 exchange, often known as a tax deferred exchange.
These benefits include:
• allows you to sell real estate or other property and defer the capital gain by reinvesting it in other property, therefore
• give you more money to invest, since you don’t have to pay tax on the sale of the property
What properties qualify? They have to be held for business or investment purposes. The exchange also has to satisfy a “like-kind” requirement. In order to qualify for a 1031, the transaction must be structured as an exchange, rather than a simple sale and repurchase. For this, you need a Qualified Intermediary (QI) who helps you to complete the transaction.
Are you interested in beginning a 1031 Exchange? Contact us today to find out how we can work with you.
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Because farmers contemplating retirement have often owned their properties for several decades, their adjusted tax basis in their farm property is often quite low. Using a 1031 exchange of like-kind property can indefinitely defer the tax if the investment property is held until death. Like-kind property does not have to be another farm. The IRS like-kind definition includes any real property the seller will use for investment purposes or that is used as trade or business property. Some examples are multifamily housing, a single family home, commercial investment property, a car wash or self-storage business.
Prior to listing the farm with a realtor or selling it to a neighbor, a retiring farmer should identify retirement financial goals, research the investment vehicles to achieve the goals, and carefully plan to follow the IRS Section 1031 rules that achieve capital gain deferral. The forty-five (45) day rule requires the seller to identify the like-kind replacement property within forty-five (45) days of the sale and close on its purchase within one hundred-eighty (180) days of the sale. Prior consideration of retirement income needs and prior identification of preferred investment vehicle or vehicles poise the seller to take advantage of the 1031 tax deferral. The deferred taxes provide additional retirement funds for investment.
If you are considering a future sale of your farmland and your machinery and equipment, please contact me for more information on a 1031 Exchange and on future estate tax implications.
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An investor wanting to defer capital gains associated with the sale of business or investment real estate, will plan to take advantage of an IRC Section 1031 exchange of like-kind property. In the forward-delayed exchange, the most commonly used 1031 exchange, the sale proceeds from the relinquished property must not be received either actually or constructively by the seller (exchanger). The IRS requires the sale proceeds to go directly to a Qualified Intermediary and remain in escrow there until the replacement property has been purchased. At closing of the replacement property, the Qualified Intermediary disburses the funds. This is one of the “safe harbors” the IRS created to enable a taxpayer to avoid actual or constructive receipt. The IRS “constructive receipt” doctrine of Section 1.1031(k) – 1 (f)(2) that states that a “taxpayer is in constructive receipt of money or property at any time the money or property is credited to the taxpayer’s account, set apart for the taxpayer, or otherwise made available so the taxpayer may draw upon it at any time.”
The mere intent of a taxpayer to sell an investment property and purchase and close on another like-kind property within the prescribed time frames does not meet the IRS requirements of a tax deferred exchange and will result in a taxable sale. Being deemed to have constructive receipt of the sales proceeds will cause the exchange to fail.
A common mistake made by investors is leaving the proceeds of the sale in the escrow account of a title company handling the sale closing until the investor later instructs the title company to apply those funds to a like-kind purchase. The IRS invokes the “constructive receipt” doctrine in these cases and requires the tax to be paid along with penalties and interest.
To ensure your sale of and subsequent purchase of like-kind property will be allowable as a 1031 exchange, contacting a Qualified Intermediary prior to the sale of your property is a must. I have been a Qualified Intermediary for 25 years and can provide the exchange documentation that restricts access to the sale proceeds to ensure your exchange qualifies for tax deferral.
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Exchange Expense: How to Keep a 1031 Completely Tax-Deferred
In order for an investor to have a completely tax-deferred 1031 exchange, he must use all of the cash from the sale of the relinquished property. Many of the sale-related expenses and certain replacement property purchase costs can be paid with exchange funds without creating a tax liability. Non-exchange expenses require payment with the investor’s own funds.
Non-Allowable Expenses and Costs:
Rather than give a buyer credit at closing, the exchange seller should pay the following items with his own funds.
When the taxpayer buys the replacement property, he should pay the following items with his own funds.
Allowable Expenses and Closing Costs:
Though official IRS rulings are mostly non-existent, except for Revenue Ruling 72-456 allowing exchange funds to pay broker commissions, tax professionals mostly concur with allowing payment at closing of the following expenses.
Issues such as constructive receipt, offsetting certain non-allowable 1031 expenses, and other issues related to use or non-use of exchange funds and the timing thereof, require prior consultation with the investor’s legal and tax advisor well before closing on the property to structure a Section 1031 exchange that is completely tax-deferred.
We would be happy to assist you in this area.
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When a multi-member LLC contemplates selling a property and wants to do a 1031 exchange, sometimes one or more members may either want to invest in a different 1031-qualified replacement property or to discontinue their real estate investment, take their proceeds and pay their taxes. If other members of the LLC want to do a 1031 exchange, a drop and swap must to be utilized to change the ownership interest to allow one or more members to go their separate way and to allow others to do a 1031 exchange.
There are several specific steps the LLC must take to accomplish a drop and swap so that it will qualify as a 1031 exchange. The Members must terminate the LLC entity and take title as tenants in common as soon as possible when contemplating a sale of the property. Because marketing the property for sale starts the process of the LLC being the seller, the drop and swap should be accomplished before marketing begins.
After the LLC members have been dropped into a tenant-in-common ownership, they need a Tenant In Common Agreement specifying how the property will be managed to qualify each owner for 1031 treatment. To provide liability protection, each owner can set up a single member LLC to own their real estate interest.
The LLC would file a final tax return as of the date of conversion and the Members would report their pro-rata share of the rental activity on their individual tax return.
The IRS has not formerly approved this technique. Properly executing a drop and swap requires early planning with a tax attorney experienced in 1031 exchanges to provide the best opportunity for this transaction to qualify for 1031 treatment.
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Considering a tax deferred exchange (1031 Exchange)?