So what is a 1031 Exchange?

Internal Revenue Code Section 1031 permits the deferral of capital gains taxes on the sale of property held for investment or productive use in a trade or a business.

In a Forward Delayed Exchange, the most common type of 1031 exchange, property is sold (relinquished Property), and the proceeds are used to purchase another property (Replacement Property) within certain timelines. To qualify for safe harbor tax deferral, the sale proceeds must be held by a Qualified Intermediary between the sale of the Relinquished Property and the purchase of the Replacement Property.

1031 permits deferral of federal capital gains taxes (15%), depreciation recapture (25%), and state taxes ( generally 8% to 9% where applicable).

How does it work?
A 1031 exchange is usually a three-way delayed exchange, referred to as a "Starker Exchange", in which an intermediary is used to facilitate the transaction. There are four basic steps:

• Seller arranges for sale of property and includes exchange language in contract.

• At closing, sales proceeds go to a Qualified Intermediary for a 1031 Exchange.

• Seller identifies potential exchange properties within 45 days of the closing.

• Seller completes 1031 exchange within 180 days of closing.

In a section 1031 transaction, these steps can also occur simultaneously. Preferably, before you sell your property, you need to consider what type of replacement property will work best for you, and whether or not you want to own a whole or partial interest in a property. Increasingly, investors are choosing to purchase a partial Tenant-in-common interest for several reasons.

Six common myths about §1031 Exchanges

You must "exchange" one property for another simultaneously - WRONG
A one-for-one simultaneous exchange need not take place. In a Forward Delayed Exchange (the most common type of exchange), property is sold (Relinquished Property) and replacement property is purchased (Replacement Property) within 180 days following the sale of the Relinquished Property. In a Reverse Exchange, however, the Replacement Property is purchased before the sale of the Relinquished Property.

The Property purchased has to be the same type as the property sold to meet "like-kind" requirements - WRONG
Any real property is "like-kind" to any other real property under 1031 guidelines. This means that a shopping center can be "like-kind" for raw land, and an office building can be "like-kind" for a residence that is held for investment purposes.

The 1031 Exchange is a loophole in the tax code - WRONG
Section 1031 has been a part of the Internal Revenue Code since the inception of the Code during the 1920's. It is a valid tax deferral strategy, which stimulates investment and is not a gimmick or loophole in the Tax Code.

I can hold the money from the sale of my property and use it to purchase replacement property without dealing with a Qualified Intermediary - WRONG
A "qualified Intermediary" provides safe harbor protection for 1031 exchanges. Without using a Qualified Intermediary and exchange may be reviewed by the IRS and invalidated by the courts. A qualified intermediary must remain completely independent and cannot have been your agent (attorney, CPA, broker, etc.) in the past 2 years.

If I am having difficulty with my purchase, I can extend the 1031 deadlines - WRONG
As general principle, there are no extension for either the 45 or the 180 day rules. However, presidential orders may provide an extension to these deadlines in cases of declared emergencies. Examples include the terrorist attacks of September 11, 2001 and recent hurricanes.

Through a 1031 Exchange, I never have to pay the capital gains taxes that would otherwise be payable - WRONG
A 1031 exchange is a tax deferral strategy. Taxes are deferred, and the cost basis transfers from the Relinquished Property to the Replacement Property. Through continued 1031 planning, it may be possible to turn this tax deferral into tax savings.

Advantages of our 1031 replacement properties
It is often difficult to locate a property that has the right purchase price, debt ratio, and closing schedule to meet the requirements for 1031 tax-deferred exchanges in the short 45-day time frame AND arrange any financing that may be necessary. Our properties have a number of advantages, such as:

• Flexible size to match your needs

• Pre-arranged financing

• No management hassles

• Potential for increased after-tax cash flow

• Economies of sale

• Can be identified and closed in a timely manner

• Investment can often be diversified into more than one property

A 1031 exchange allows you to exchange your management-intensive property for an institutional-quality property with the potential to generate steady income, tax benefits and appreciation. With a 1031 exchange property, you no longer have to feel burdened by your real estate. Through your management contract, a manager will be retained to manage the asset while you enjoy all the benefits of income property ownership and freedom from management duties.

Your income from the replacement property may be higher than what you were receiving from the original property. You can earn substantial cash flow that may be up to 60% sheltered by the depreciation of your new basis in your TIC purchase.

No capital gains taxes may be due until the replacement property is eventually sold. If you shuffle off this mortal coil while owning a property, your heirs will receive a stepped up basis and the capital gains tax will be completely avoided.

How do I get started?
Discuss your specific needs with your registered representative who will be happy to answer your questions and provide you with the information you need to consider a 1031 exchange or a reverse 1031 exchange.

1031 Do's & Don'ts

DO advanced planning for the exchange. Talk to your accountant, attorney, broker, financial planner, lender and Qualified Intermediary.

DO NOT miss your identification and exchange deadlines. Failure to identify within the 45-day identification period, or failure to acquire replacement property within the 180-day exchange period will disqualify the entire exchange. Reputable Intermediaries will not act on back-dated or late identifications.

DO keep in mind these three basic rules to qualify for complete tax deferral:

• Receive only "like-kind" replacement property.

• Use all proceeds from the relinquished property for purchasing the replacement property.

• Make sure the debt on the replacement property is equal to or greater than the debt on the relinquished property. (Exception: a reduction in debt can be offset with additional cash; however a reduction in equity cannot be offset by increasing cash.)

DO NOT try to do a 1031 exchange yourself using your CPA or attorney to hold title or funds. IRS regulation requires a Qualified Intermediary to properly complete an exchange. Call us for the name of one that operates in your area.

DO attempt to sell before you purchase. Occasionally exchanges find the ideal replacement property before a buyer is found for the relinquished property. If this situation occurs, a "reverse" exchange (buying before selling) may be necessary. Exchangers should be aware that reverse exchanges are considered a more aggressive exchange variation because no clear IRS guidelines exist.

DO NOT dissolve partnerships or change the manner of holding title during the exchange. A change in the Exchanger's legal relationship with the property may jeopardize the exchange.

1031 Terminology

Like-Kind Property
Like-kind refers to the type of property being exchanged. You can exchange any real estate investment for any other type of real estate investment. For example, vacant land can be exchanged for rental property. In most cases your personal residence is not like-kind investment property.

Exchanging Up
To accomplish a fully tax-deferred exchange, the rule of thumb is "exchange even or up in value; exchange even or up in equity and in debt."

Boot
To the extent that you do not exchange even or up in value and/or exchange even or up in equity and debt, you will have received non-qualifying property ("boot") in your exchange. If boot is received, tax is computed on the amount of gain on the sale or the amount of boot received - whichever is lower.

Typical Exchange Addendum Language for Sales Contracts "Buyer hereby acknowledges that it is the intent of the Seller to effect an IRC Section 1031 tax deferred exchange which will not delay the closing or cause additional expenses to the Buyer. The Seller's rights under this agreement may be assigned to a Qualified Intermediary, named by Seller, for the purpose of completing such an exchange. Buyer agrees to cooperate with the Seller and the Qualified Intermediary in a manner necessary to complete the Exchange"