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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)?