Ted will ensure compliance with IRC 1031 for a valid 1031 Exchange.
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A 1031 exchange accommodator, also known as a Qualified Intermediary (QI), plays a crucial role in facilitating a 1031 exchange, which allows real estate investors to defer capital gains taxes by exchanging one investment property for another. Here are four benefits of working with a 1031 exchange accommodator:
Tax Deferral: The primary benefit of a 1031 exchange is the ability to defer capital gains taxes on the sale of an investment property. By using a qualified accommodator, investors can ensure that all legal and procedural requirements are met, allowing them to defer taxes and reinvest the full amount of their proceeds into a new property.
Compliance with IRS Regulations: The IRS has strict rules governing 1031 exchanges, including specific timelines and documentation requirements. A qualified accommodator ensures that all steps of the exchange comply with these regulations, reducing the risk of the transaction being disqualified, which could result in immediate tax liabilities.
Streamlined Process: The 1031 exchange process can be complex and involves several steps, including the sale of the original property, the identification of replacement properties, and the eventual purchase of the new property. An experienced accommodator manages these logistics, ensuring that the exchange proceeds smoothly and within the required timelines.
Expert Guidance: A 1031 exchange accommodator provides expert advice and guidance throughout the process. They can help investors navigate potential pitfalls, understand the implications of different exchange structures, and make informed decisions that align with their investment goals. Their expertise can be invaluable in maximizing the benefits of the exchange.
Ted Dowding “aka” The Net Lease King is the CEO / Managing Broker of TD Commercial Group and founder of NetLeaseWorld.com. Ted is the #1 Net Lease Buyside Broker in the USA since 2021. Ted specializes in National Net Lease Investment Sales with $2.15B+ In Career CRE Closings. His Brokerage TD Commercial Group “TD” = “Technology Driven”, Leverages proprietary technology to make searching for and secure the highest quality NNN Assets available.
Ted and his team are experts in identifying, negotiating, and securing Net Lease Assets to help clients to meet their 1031 Exchange needs or add to their portfolios. Ted can get product exposure in the marketplace more quickly than most competitors and quickly procure offers using his extensive buyer database.
A Qualified Intermediary (QI) is essential for a 1031 exchange. The QI holds the proceeds from the sale of the property and then uses those funds to acquire the replacement property on behalf of the investor. This is crucial to ensure that the investor does not take control of the funds, which would invalidate the exchange.
1031 exchange services prepare all necessary legal and tax documentation for the exchange process. This includes the Exchange Agreement, Assignments of the Purchase and Sale Agreements, and other required forms to comply with IRS regulations.
These services often include consultation to help investors understand the process and plan their exchanges strategically. They may provide advice on timing, property selection, and ways to maximize the benefits of the exchange.
The IRS mandates that replacement properties must be identified within 45 days of the sale of the relinquished property. 1031 exchange services assist investors in adhering to this timeline by providing guidance on the identification process and ensuring all necessary paperwork is completed.
The QI manages the escrow of funds between the sale of the relinquished property and the purchase of the replacement property. This service ensures that the funds are securely held in compliance with IRS rules, often in separate, interest-bearing accounts.
1031 exchange services coordinate with the closing agents for both the sale of the relinquished property and the purchase of the replacement property. They ensure that all documents are correctly signed and executed, and that the exchange is completed within the required 180-day period.
A 1031 Exchange is a tax deferral tool that allows the seller of qualifying real property to defer taxes on their transaction including Capital Gains, Depreciation Recapture, and Net Investment Income Tax, so long as the proceeds from the sale are used to acquire other qualifying, real property. Multiple requirements must be adhered to for a valid 1031 Exchange.
A Qualified Intermediary ensures compliance with IRC 1031 for a valid 1031 Exchange. This includes the following:
• Acquires relinquished property from the Exchanger and transfers it to the Buyer
• Ensures Exchanger is not in actual or constructive receipt of any of the funds from the sale of the relinquished property
• Acquires replacement property from the Seller and transfers it to the Exchanger
• Structures the exchange per IRC 1031
• Prepares all related documentation
• Monitors and instructs the Exchanger of
action to ensure maintained compliance throughout the exchange
All 1031 Exchanges, regardless of the type, have a 45-day identification period and a 180-day exchange period.
For a 1031 Exchange to be in accordance with IRC § 1031, within 45-days of the close of the sale of the Relinquished Property the taxpayer must identify their potential replacement property(ies) in writing to the qualified intermediary. The replacement property(ies) description must be unambiguous and specific, using a physical address or legal description.
In relation to the 45-day identification period, there are rules that a taxpayer must follow when identifying their potential replacement property(ies). There are three distinct identification rules that the taxpayer can use, and they can choose the appropriate rule for their specific exchange situation. The three rules are as follows:
3.95% Rule: A taxpayer can identify infinite properties, the combined value of which exceed 200% of the value of what they sold, but they must acquire at least 95% of the fair market value of the properties they identify.
All 1031 Exchanges have a 180-day time limit starting from the day of the close on the sale of the Relinquished Property. If the taxpayer has not completed the purchase of the Replacement Property before or on day 180, then the exchange is closed, and the taxpayer must recognize and pay taxes on the proceeds from their Relinquished Property sale. There are no extensions or exceptions available.
Since 1991, IRC § 1031 has required the use of an impartial third party to hold the proceeds from the Relinquished Property sale until the close on the Replacement Property. This third party is known as a Qualified Intermediary.
Not only does the Qualified Intermediary hold the funds during the exchange period, but they also help structure the exchange, prepare the exchange documentation, continuously monitor, and guide the taxpayer to ensure compliance of the exchange in accordance with Section 1031 at both the state and federal level.
While there are no federal regulations governing Qualified Intermediaries, with the help of the Federation of Exchange Accommodators (FEA), many states started state-level requirements to uphold high professional standards for Qualified Intermediaries conducting exchanges in their states. The requirements can vary state to state, but typically include some or all of the following:
The foundation of all successful 1031 Exchanges is laid by the Qualified Intermediary. Do your due diligence in researching Qualified Intermediaries to ensure you are not only getting the best service possible, but to ensure your deferred capital gains tax will hold up above IRS review.
In order to defer ALL capital gains and depreciation recapture taxes from the sale of the Relinquished Property the taxpayer must pay an equal or higher price for the Replacement Property than the Relinquished Property was sold. Should any debt or amount not be reinvested this portion, called boot, would be taxable.
Boot is any non-like-kind property or properties that does not qualify, which could include cash, notes, partnership interests, securities, inventory, or property held primarily for sale not investment, etc. Boot is categorized in two types: cash boot, which is cash received, and mortgage boot, which is any reduction in loan or debt on the exchange. Any boot received during a 1031 Exchange is subject to taxation as either depreciation recapture or capital gain.
It is important to note that any credits on the settlement statement directly paid out to the taxpayer may also result in boot and a taxable event. If certain situations are not handled properly in the construction and administration of the 1031 Exchange, it can result in credits on the settlement statement. Here are couple common situations:
In summary, to avoid a taxable event in entirety, the taxpayer must reinvest equal to or greater than the value of the sale of the Relinquished Property. However, the taxpayer may take cash out, creating boot, but they will have to pay the associated taxes.
One of the most common questions asked is whether or a not a vacation property qualifies for a 1031 Exchange. There are three basic rules for including a vacation home in a 1031 Exchange that were introduced by the IRS in 2008.
For a vacation home to qualify as relinquished property in a 1031 Exchange, first the vacation home must have been held by the taxpayer for a minimum of 24 months immediately preceding the exchange. Second, the vacation home must have been rented at fair market value for at least 14 days in each of the 12-month periods. Third, the property owner cannot have used the vacation home personally for more than 14 days or 10% of the days the home was rented out (whichever is greater) within both 12-month periods.
The rules for a vacation home as a replacement property are the same as above. The property must be held for a minimum of 24 months after the close of the exchange; the property must be rented out at fair market value for at least 14 days in each 12-month period; and the taxpayer cannot use the vacation home for personal use more than 14 days or 10% of the days it was rented out (whichever is greater) in each 12-month period.
There is one small exception to the days a taxpayer can use both the relinquished and replacement properties, which states that the taxpayer can use the home for personal use above and beyond the 14 days or 10%, If the overage was used to complete improvements or maintenance. If a taxpayer plans to utilize this exception, they should keep all receipts of maintenance, or improvements completed during the duration of their stay to ensure they comply with the regulations upon scrutinization.
Following the rules above, a vacation property can be eligibly property for a 1031 Exchange. It is strongly recommended that a taxpayer contemplating a 1031 Exchange involving vacation property discuss the transaction with their tax and legal counsel before doing so.
One of the most common questions asked is whether or a not a vacation property qualifies for a 1031 Exchange. There are three basic rules for including a vacation home in a 1031 Exchange that were introduced by the IRS in 2008.
For a vacation home to qualify as relinquished property in a 1031 Exchange, first the vacation home must have been held by the taxpayer for a minimum of 24 months immediately preceding the exchange. Second, the vacation home must have been rented at fair market value for at least 14 days in each of the 12-month periods. Third, the property owner cannot have used the vacation home personally for more than 14 days or 10% of the days the home was rented out (whichever is greater) within both 12-month periods.
The rules for a vacation home as a replacement property are the same as above. The property must be held for a minimum of 24 months after the close of the exchange; the property must be rented out at fair market value for at least 14 days in each 12-month period; and the taxpayer cannot use the vacation home for personal use more than 14 days or 10% of the days it was rented out (whichever is greater) in each 12-month period.
There is one small exception to the days a taxpayer can use both the relinquished and replacement properties, which states that the taxpayer can use the home for personal use above and beyond the 14 days or 10%, If the overage was used to complete improvements or maintenance. If a taxpayer plans to utilize this exception, they should keep all receipts of maintenance, or improvements completed during the duration of their stay to ensure they comply with the regulations upon scrutinization.
Following the rules above, a vacation property can be eligibly property for a 1031 Exchange. It is strongly recommended that a taxpayer contemplating a 1031 Exchange involving vacation property discuss the transaction with their tax and legal counsel before doing so.
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