NewswireToday - /newswire/ -
New Orleans, LA, United States, 2006/05/01 - Most real estate professionals know that capital gains taxes can be deferred with an exchange of property meeting the requirements of Internal Revenue Code §1031, but not all understand how an exchange differs from a sale..
An exchange requires a transfer of property for another property, where a sale of property is a transfer of property for money.
The primary advantage with an exchange is to:
1) defer the capital gains tax, even though there has been a reduction in the capital gains tax rates, the benefits of a §1031 exchange can be very substantial; and,
2) to fully use your built up equity for acquisition of another property, hopefully of investment grade.
The rules of §1031 can trap the unwary and can result in a loss of some or all of the tax-deferral benefits. The use of legal, real estate and tax advisers familiar with the rules of a §1031 is strongly recommended. As you transact exchanges involving multiple properties, there are other rules that can apply, including, but not limited to, incidental property, single or multiple exchanges, and the same-taxpayer requirement.
Generally, when you exchange one property, you must identify the potential replacement property within 45 days from transfer of the relinquished property and acquire it within 180 days from the same transfer date, unless the transfer occurs later in the year, when the 180-day period can be shortened by the due date of your tax return. if you transfer multiple relinquished properties that close on different dates through one exchange, the identification and exchange periods begin on the date of transfer for the first relinquished property.
It may be challenging to use one exchange for multiple relinquished properties closing on different dates. If the closing date for one or more of the properties is delayed or cancelled, acquisition of the replacement property may be affected. It might be better to structure each closing as a separate exchange and to gain some flexibility in identifying and closing on replacement property However, assuming that the apartment buildings are exchanged using one escrow closing to a single buyer under one contract, the IRS could argue that all of the closings are considered one exchange, which could result in violation of the identification rules.
While there are no clear rules on what is a single and what is a multiple exchange, there are a number of factors to consider:
• Is there a single agreement or are there separate agreements for sale of the relinquished properties?
• Is one escrow or title company handling the closings?
• Is there one qualified intermediary or are there different qualified intermediaries being used for the exchanges?
• Are the properties being closed on different dates?
• Are the relinquished properties contiguous or operated as a single property?
If separate exchanges are used, it is important to retain legal/tax advisors and make sure that each relinquished property closing is a separate and distinct from the other closings.
Same taxpayer requirement
While it would seem obvious, the same taxpayer that transfers the relinquished property needs to acquire the replacement property. There are circumstances when the type of entity owning the relinquished property will be different in name from the one acquiring the replacement property. For example, the replacement property lender may require that the owner be a bankruptcy remote entity. In most states, a single-member limited liability company (LLC) is permitted. The federal tax laws permit an LLC to elect to he taxed as a disregarded entity, an association or as a sole proprietorship. If the election is made to be a sole proprietorship, the entity is considered disregarded for tax purposes. The IRS has approved the use of a single-member LLC for acquisition of replacement property. This is commonly used in the structuring of Tenants–In-Common (TIC) or Private Annuity Trust transactions.
If you are considering a §1031 exchange of any kind or the purchase of a Tenant In Common interest, be sure to seek the advice of legal counsel and/or other tax advisors on your specific circumstances. Without adequate knowledge, you could end up paying all or part of the capital gains taxes you are trying to defer.