Interested In A 1031 Exchange? Read This Before It's Too Late
by Angilina Taylor 1031 Exchange Expert, Tax ConsultantNo matter how attractive an investment may appear, as an investor, you
must study it before investing. Otherwise, at some point in time during the
transaction, you’ll find yourself in a no man’s land, particularly in case of a
1031 Exchange. You may have heard or read somewhere that using a 1031 Exchange,
an investor can defer capital gains taxes on exchanging like-kind properties,
which otherwise they would be liable to pay. However, that’s not complete
knowledge. It’s not even half of what 1031 Exchange investors should
know.
Like-Kind Definition -
Let’s take the example of properties that can be exchanged using 1031
Exchanges. You can’t exchange ‘any’ property and defer taxes taking advantage
of this unique investment structure. As per the guidelines, properties involved
in 1031 Exchanges must be held for use in trade, business or for investment
purposes. In other words, you can only exchange an investment property for
another using a 1031 Exchange. However, it doesn’t mean that the relinquished
and replacement properties must serve the same purpose. For example, using a
1031 Exchange, you can exchange a retail property for an industrial property or
a NNN property and not only for another retail property.
1031 Exchange Property Rules –
Though some limitations have been imposed on the number of properties
that can be acquired as 1031 Exchange replacement properties, however, an
investor can identify any number of replacement properties thanks to the
following rules:
- The
Three Property Rule – As per this rule, an investor can identify up
to three replacement properties irrespective of their values, and not all
of the identified properties need to be purchased.
- The
200% Rule – Using this rule, an investor can identify any
number of replacement properties as long as the combined value of the
identified properties doesn’t exceed 200% of the value of the relinquished
property.
- 95%
Rule – As
per this rule, an investor can identify any number of replacement
properties as long as the value of the property acquired at the end of the
exchange is at least 95% of the value of the relinquished property.
Though 1031 Exchanges do guarantee tax deferment, however, 1031 Exchange
investors mustn’t take it guaranteed. In other words, you could lose the
opportunity of deferring taxes if any gain is recognized at the end of your
1031 Exchange. The term ‘Boot’ is used to define such profits. A Boot can be
defined as ‘something given in addition to.' In 1031 Exchanges, a boot is
defined as the ‘cash received by the investor.’
Technically, your 1031 Exchange
will no longer be valid if you received boot in any of the following ways:
- Cash
– Cash
boot is defined as the money received by the investor at the end of a 1031
Exchange. For example, if the value of the relinquished property turns out
to be greater than that of the replacement property, then it will result
in a cash boot.
- Debt
Reduction – Consider
a case when the debt on the replacement property is less than that on the
relinquished property. This kind of boot is known as Debt Reduction.
- Sale
Proceeds – In
case you end up spending a part of your proceeds from the relinquished
property on non-qualified expenses like utility bills, escrow agent’s fee,
etc. then it will immediately nullify your chances to defer capital gains
taxes.
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Created on Nov 7th 2019 07:08. Viewed 222 times.