General Information on Exchanges
A 1031 exchange (tax-deferred exchange) is one of the most powerful tax
deferral strategies remaining available for taxpayers. Anyone involved
with advising or counseling real estate investors should know about tax-deferred
exchanges, including Realtors, lawyers, accountants, financial planners,
tax advisors, escrow and closing agents, and lenders. Taxpayers should
never have to pay income taxes on the sale of property if they intend
to reinvest the proceeds in similar or like-kind property.
The Advantage of a 1031 Exchange is the ability of a taxpayer to sell
income, investment or business property and replace with like-kind replacement
property without having to pay federal income taxes on the transaction.
A sale of property and subsequent purchase of a replacement property doesn't
work, there must be an Exchange. Section 1031 of the Internal Revenue
Code is the basis for tax-deferred exchanges. The IRS issued "safe-harbor"
Regulations in 1991 which established approved procedures for exchanges
under Code Section 1031. Prior to the issuance of these Regulations, exchanges
were subject to challenge under examination on a variety of issues. With
the issuance of the 1991 Regulations, tax-deferred exchanges became easier,
affordable and safer than ever before.
The Disadvantages of a Section 1031 Exchange include a reduced basis for
depreciation in the replacement property. The tax basis of replacement
property is essentially the purchase price of the replacement property
minus the gain which was deferred on the sale of the relinquished property
as a result of the exchange. The replacement property thus includes a
deferred gain that will be taxed in the future if the taxpayer cashes
out of his investment.
There is more than one way to structure a tax-deferred exchange"
under Section 1031 of the Internal Revenue Code. However, the 1991 "safe-harbor"
Regulations established procedures which include the use of an Intermediary,
direct deeding, the use of qualified escrow accounts for temporary holding
of "exchange funds" and other procedures which now have the
official blessing of the IRS. Therefore, it is desirable to structure
exchanges so that they can be in harmony with the 1991 Regulations. As
a result, exchanges commonly employ the services of an Intermediary with
Exchanges can also occur without the services of an Intermediary when
parties to an exchange are willing to exchange deeds or if they are willing
to enter into an Exchange Agreement with each other. However, two-party
exchanges are rare since in the typical Section 1031 transaction, the
seller of the replacement property is not the buyer of the taxpayer's
exchange information provided courtesy of 1031 Corporation