We work with qualified Exchange Intermediaries to help you reach your investment goals.
A tax deferred exchange allows an taxpayer to exchange a real estate property used in a business or an investment property for other like kind property via the exchange process. By exchanging, the taxpayer is able to defer the payment of capital gains tax to a later time and use the funds that otherwise would go to pay the tax to acquire additional property. Currently the combination of state and federal taxes averages from 15% -25% Federal tax and 9.3% California State tax for totals between 24% to almost 34% depending on depreciation recapture. This can be a significant factor in the economics of the investment.
The exchange can be structured as a simultaneous close transaction or a deferred exchange. The exchange is a simultaneous transaction when both the property being sold by the taxpayer and the property being acquired by the taxpayer are closed at the same time. The taxpayer must be able to obtain the cooperation of one of the other parties to the exchange to go through title to effect the exchange. This is becoming increasingly difficult to do in today’s litigious world. In addition, it if often necessary that both properties be in escrow at the same company to avoid the transfer of collected funds from interfering with the simultaneous nature of the exchange.
A deferred exchange is used when a taxpayer has found a buyer for his property, but is not in a position to acquire the replacement property at the time the relinquished property is set to close.
The rules involving the structure of an exchange have evolved through a series of court cases, changes to the Internal Revenue Code and Regulations and Revenue Rulings since 1921. Each exchange must be carefully structured to fall within these rules.
The real estate market has changed significantly over the last few years and as a result many of the questions we get from investors have changed as well. Below are some of the common questions we have been fielding over the last 24 months:
Q: If I buy a foreclosure, fix it up and sell it, will it qualify for a 1031 Exchange?
A: Generally speaking, no. The properties involved in a 1031 Exchange need to be “held for investment purposes.” Buying and flipping would not likely meet the “hold for investment test” and is not eligible for 1031 Exchange. A quick flip could be taxed as a short term capital gain or as a dealer transaction and at ordinary income rates depending upon the facts. Ordinary income taxes range from 10-35% at the federal level and are as high as 9.55% at the state level.
Q: The buyer for my 4-plex wants me to carry a note for $100K. Will this jeopardize my 1031 Exchange?
A: A 1031 Exchange can still be accomplished with seller financing, however, the process is more complex. The exchange intermediary has to take title to the note upon the close of the relinquished property and during the exchange period the note has to be exchanged or replaced for cash. This can be accomplished by the taxpayer coming out of pocket with his/her own cash or simply by selling the note to a third party. The note can also be assigned to the seller of the replacement property as part of the consideration but it is not likely the seller would agree to accept the note.
Q: I want to make an offer on a replacement property, but my 1031 Exchange downleg (relinquished) property has not sold yet. What are my options?
A: There are several options for an investor in this situation. The offer on the replacement property can be made contingent upon the sale of the downleg property. The offer can be made with an unusually long escrow period to ‘buy time’ in hopes the downleg property will sell first. Finally, the investor can also enter into a “Reverse Exchange”. In a Reverse Exchange, Asset Services Inc. would have it’s separate Reverse Exchange Titleholder Entity actually take title to either the relinquished or the replacement property. Once the downleg property sells, the Titleholder Entity will transfer title of the new property to the investor. A Reverse Exchange is complex so an investor contemplating a Reverse Exchange should contact us (949-494-1400) prior to making an offer on the replacement property.
Q: I have no increase in value on my property, but my CPA said I still owe a tax?
A: Although there may no increase in value in a property, a taxable gain may still be due resulting from depreciation taken over the life of the property. The depreciation recapture tax rate is currently set at 25%. Conducting a 1031 Exchange will allow an investor to defer the payment of this tax.