1031 Tax Free Exchange Information
WRA Capital Partners LLC has a diverse staff with over 25 years of experience in real property sales, asset management and investment services. We are familiar with the IRS Tax Code, as well as the process of a Section 1031 Tax Free Exchange and are qualified to help complete your exchange promptly, professionally, and legally. WRA Capital Partners LLC provides its services as investment advisors for simultaneous, delayed, improvement and construction exchanges. We perform these sales and purchases while working closely with the Qualified Intermediary to avoid any pitfalls in your exchange.
Recently, WRA Capital Partners LLC acted as both Investor Advisor and Mortgage Banker for a group of New York based investors who recently purchased three new Rite Aid Drug Stores located in Georgia and Ohio to complete a Section 1031 Tax Free Exchange. The aggregate purchase price was in excess of $6,000,000. Additionally, we arranged long-term mortgage financing covering 95% of the purchase price, through a conduit of a major international investment bank. WRA Capital Partners, LLC, handled the acquisition and financing. We provide our clients with a full range of investment services including contract negotiations, lease and environmental review, due diligence and coordination with counsel to assure contract and financing compliance and a timely closing.
Below we have provided a brief overview of what the 1031 Tax Free Exchange is, the different types of exchanges, along with the rules, constraints, and identification of an exchange property.(See Disclaimer)
Internal Revenue Code Section 1031
Section 1031 of the Internal Revenue Code related to the disposition of property that is held for use in productive trade or business or held for investment. If performed properly, code section 1031 provides an exception to the rule requiring recognition of gain upon the sale or exchange of property. In other words, if the requirements of a valid 1031 exchange are met, capital gain recognition will be deferred until the taxpayer chooses to recognize it. This basically results in an interest free loan from the IRS on the taxes which otherwise would be payable in the year of disposition of the property.
For an exchange to be one hundred percent tax deferred, the Exchanger must acquire replacement property that is of equal or greater value and spend all of the net proceeds from the relinquished property.
What is 1031 Tax Free Exchange?
A tax-deferred exchange is a sale of the relinquished property to one party and a purchase of the replacement property from another property. Many specific requirements must be satisfied in order to complete the exchange properly. When this certain criteria is met, as defined in Internal Revenue Code Section 1031, the taxes on any capital gain realized from the sale of the relinquished property are deferred. The transaction is basically little different from an ordinary sale and purchase of property, except that certain documentation must be present to show that the transfers are intended to be part of an exchange and not a sale. Overall, exchanges represent a legal tax deferral strategy, which allows investors and property owners the opportunity to move equity from one investment to another.
What Are The Different Types Of Exchanges?
To qualify as a Simultaneous Exchange, both the relinquished property and the replacement property must close and record on the same day. There is significant danger and legal exposure in this attempt since many unforeseen events can cause the closing and recordation to be delayed on one of the properties, leaving the investor with a failed exchange and the obligation of taxes that would otherwise be deferred. However the 1031 regulations contain what is referred to as a "Safe Harbor" provision, which does provide that in the event a facilitator or intermediary is used in a simultaneous exchange, and the transaction proves not to be simultaneous, the exchange will not fail simply for that reason.
The Delayed, or Starker exchange is the most common type of exchange today. The IRS formally recognized the delayed exchange for the first time in 1984. In this exchange, the relinquished property is sold at Phase 1, and after a delay the replacement property is acquired at Phase 2. There are time constraints and rules that must be followed for the exchange to qualify for deference.
The Improvement and Construction exchange is when the replacement property requires new construction or significant improvements to be accomplished. These changes are completed to make the property viable for the specific purpose the exchangor has in mind for the property. Such construction or improvements can be completed as part of the exchange process. Therefore, if the replacement property is of lesser value than the relinquished property at the time of the original transaction, the improvement or construction costs can bring the value of the replacement property up to an exchange level that would allow the transaction to remain tax-deferred.
What Requirements Must Be Met For A Delayed Exchange?
There are three basic exchange rules must be met to fully defer taxes on the gain realized from the sale of the relinquished property:
What Is A 1031 "Like Kind" Property?
Therefore, not only is rental or other income property qualified, so is unimproved property that has been held as an investment. The unimproved property can be exchanged for improved property of any type, or vice versa. Also, one property may be exchanged for several, or vice versa. This means that almost any property that is not a personal residence or second home is eligible for exchange under Section 1031.
What Are The Time Constraints For A 1031 Delayed Exchange?
The Exchanger has a maximum of 180 days from the closing of the relinquished property or the due date of that year's tax return, whichever occurs first, to acquire the replacement property. This is called the Acquisition Period. The first 45 days of that period is called the Identification Period. During the 45 days, the exchangor must identify the property, which will be used for replacement. The identification must be in writing, signed by the exchangor and, received by the facilitator or other qualified party, faxed, postmarked or otherwise identifiably transmitted (such as Federal Express or other dated courier service). This must all occur within the 45-day period. Failure to accomplish this identification will cause the exchange to fail.
What Qualifies A Correct Identification?
Three rules exist for the correct identification of replacement properties:
These identification rules are absolutely critical to any exchange. No deviation is possible and the IRS will grant no extensions.
Parties Involved In The Exchange Transaction
Broker/Agent: The broker/agent is involved in performing the sales and purchases of the "like kind" property. Clearly understanding the exchange concept, the agent/broker should work closely with the Qualified Intermediary to avoid pitfalls and give guidance throughout the process. WRA CAPITAL PARTNERS LLC PROVIDES THESE SERVICES.
Qualified Intermediary: The Intermediary is the entity, which structures, consults, guides and documents the exchange transaction from beginning to end. A sound Intermediary will provide safety and securities for the funds held and provide the technical experience needed to maintain the integrity of the exchange.
Escrow/Title: The Escrow Holder/Closing Agent is responsible for properly documenting the exchange with the help of the Intermediary. The teamwork between the Closing Agent/Escrow Officer and the Intermediary is the most important aspect of a successful exchange team.
Tax/Legal Advisors: Many taxpayers will include the advice or guidance of competent advisors prior to the exchange. Advisors will typically interface with the Intermediary.
How A Delayed Exchange Would Be Handled At WRA Capital Partners LLC
A client's exchange would be carefully planned by one of our experienced 1031 exchange brokers. Once the planning is complete, the exchange structure and timing are decided, the relinquished property is sold and the transaction is closed. A facilitator becomes the repository for the proceeds of the sale. The money is kept in the facilitator's secured account until the replacement property is located and instructions are received to fund the replacement property purchase. The funds are wired or sent to the closing attorney and the property is purchased for the exchangor and deeded directly to him. All the necessary documentation to clearly identify the transaction as an exchange would be provided by WRA, such as Exchange Agreement, Assignment Agreement and supplemental escrow instructions.
For more information on the 1031 Tax Free Exchange Process call, write, or email Frank T. Chiarello:234-19 41st Avenue
Douglaston, NY 11363
1031 Tax Deferred Exchange: A deferred exchange is an exchange in which, pursuant to an agreement, the taxpayer transfers property held either for productive use in a trade or business or for investment and subsequently receives property to be held whether for productive use in a trade or business or for investment.
Basis: A method of measuring investment property for tax purposes.
Exchanger: Taxpayer, Client
Growth Factor: Interest earned during the exchange that is payable at the end.
Relinquished Property: Property being sold by the Exchanger, which is commonly called Phase I property.
Replacement Property: Property being acquired or the target property being brought be the Exchanger, which is commonly called Phase II property.
Simultaneous/Concurrent: An exchange without any time span between the sale and the buy.
Starker: The name of a taxpayer in the U.S. Court of Appeal case, which authorized Delayed Exchanges. The term a "Starker Exchange" is no longer used to describe a Delayed Exchange.
Like-Kind Property: Any real property in exchange for another real property if the properties are held for productive use in trade or business or for investment purposes.
Sequential Deeding: A property is actually deeded to the Intermediary and the Intermediary deeds to the ultimate owner.
Direct Deeding: The vested owner deeds directly to the ultimate owner without deeding to the Intermediary. This eliminates the duties of the Qualified Intermediary to acquire and transfer the relinquished property and acquire and transfer the replacement property, but the Intermediary still advises and handles the money involved in the exchange.
Identification Period: The replacement property must be identified within 45 days of the close of escrow/closing of the relinquished property. This 45-day rule is very strict and is not extended if the 45th day should happen to fall on a weekend or legal holiday.
Exchange Period: The replacement property must be received by the taxpayer within the "Exchange period", which ends on the earlier of 180days after the date on which the tax payer transferred the property relinquished or the due date of the taxpayer's return for the taxable year in which the transfer of the relinquished property occurs (i.e. April 15). Due to the Taxpayer's ability to extend the date of filing, the exchange period is usually 180 days.
Constructive Receipt: The control of the cash proceeds without actual physical possession by Exchanger or their agent.
Boot: A taxable situation. This situation occurs when the property received by the Exchanger is not "Like-Kind" making the exchange taxable. There are two types of boots, cash and mortgage.
Cash Boot: It consists of any funds received by the Exchanger, either actually or constructively. If the Exchanger does not spend all of the proceeds from the sale of the relinquished property, he/she will have an actual receipt of the balance not spent and pay taxes on that amount. Constructive receipt of funds occurs when the Exchanger carries back a note from his/her Buyer of the relinquished property, then sells that note at a discount. The Exchanger never actually receives funds for the discounted amount, however, he/she has constructively received that discount and pays tax on that amount.
Mortgage Boot: This occurs when the Exchanger does not acquire equal or greater debt on the replacement property. The Exchangers are considered to be "Relieved Of Debt", which is perceived as taking a monetary benefit out of the exchange. Therefore, the debt relief portion is taxable, unless offset by adding equivalent cash to the transaction.
Exchange Agreement: A deferred Exchange is an exchange in which, pursuant to an agreement, the Exchanger transfers the relinquished property and subsequently receives the replacement property.
Safe Harbor: A term used to identify the requirements to protect the Exchanger's monies as well as the "Qualified Intermediary".
Deferred Exchange: A term used in place of " Non-Simultaneous Exchange" or "Starker Exchange". This is the type of exchange where the Exchanger utilizes the Exchange Period described above.
Qualified Intermediary: An Intermediary is the company who acts as the accommodator in the exchange. A qualified intermediary is identified as follows: 1) Not a related party (e.g. agent, attorney broker, etc) 2) Receives a fee; 3) Acquires the relinquished property from the Exchanger and 4) Acquires the replacement property and transfers it to the Exchanger.
For more information on WRA Capital Partners' 1031 Tax Free Exchange Services, call Frank T. Chiarello, at (718) 224-9500 x 130 or contact us.
DisclaimerThis material is designed to only provide information concerning I.R.C. Section 1031 Tax-Deferred Exchange. It is not intended to provide or replace legal, accounting or other professional counsel. It is recommended that you consult with your company management and/or tax counsel regarding any specific situations or how the information contained in this material relates to your company's policy and/or local practices.