Mid Atlantic Real Estate Journal — December 6 - 19, 2013 — 15A
www.marejournal.com
By Sefi Silverstein, CPA , Wilkin & Guttenplan, P.C. 1031 Exchanges of Property T ax I ssues & A ccounting
W
hen properly struc- tured, real estate owners can defer
a like-kind exchange by allow- ing for the purchase/sale of the properties to occur at different times during an allowable ex- change period. The QI cannot be a related party or an exist- ing agent of the real estate owner (such as an accountant, attorney, employee, real estate broker, etc.). Deferred exchanges can be completed either as a forward exchange (the relinquished property is sold first; the re- placement property is acquired after) or a reverse exchange (the replacement property is acquired first; the relinquished property is sold after). The ini-
tial step in a deferred exchange is to enter into a written agree- ment with a QI who will facili- tate the tax deferred exchange. Second, with respect to a for- ward exchange, the QI will contract to sell the property on the owner ’s behalf and receive the sales proceeds. The sales proceeds are deposited into an escrow account created by the QI. The funds will be used to acquire the replacement property. The seller will then need to identify replacement property within 45 days of the closing. In identifying the re- placement property, the seller has two options: 1) identify up
to three properties the investor is considering, or 2) identify as many properties as desired as long as the cumulative fair market values of the identi- fied properties do not exceed 200 percent of the fair market value of the relinquished prop- erty. The second option works best when the seller desires to exchange their property for multiple properties. (One example for acquiring sev- eral replacement properties is if parents prefer that their children and grandchildren inherit separate properties instead of jointly inheriting one larger property). The final
step to complete the exchange is to close on the replacement property. The closing must be completed within 180 days of the original sale. Although not as popular, in a reverse exchange, the replace- ment property is acquired first through the QI. After the acquisition, the owner will have 45 days to identify the property/properties they will sell to complete the exchange. The closing on the relinquished property will need to be com- pleted within 180 days of the acquisition date of the re- placement property. After the Continued on page 22A
taxes on long term capital gains by en- tering into a like-kind e x c h a n g e transaction. Because o f the new tax laws in effect
Sefi Silverstein
as of 2013, there may be an even greater incentive to con- sider a 1031 exchange: long term capital gains tax rates have increased from 15% to 20% for taxpayers in the high- est income tax bracket; and there is a new 3.8% Medicare surtax on investment income, including long term capital gains. For many, these two tax changes alone can create an additional tax burden. Below is an overview of the mechanics of a like–kind exchange which would allow for the deferral of the gain. A like-kind exchange is a viable option for a real estate investor who is selling a prop- erty which has appreciated in value or, has a low basis from previous depreciation deductions, and is planning to reinvest the proceeds into one or more newly acquired properties. The IRS allows for this tax deferral when a real estate owner essentially “exchanges” one property for another “similar” property (or properties). In order to receive a full tax deferral treatment, the transaction must meet certain criteria: the cost of the replacement property must be equal to, or greater than, the selling price of the property relinquished; the net equity in the replacement property can- not be less than the net equity in the property relinquished; both properties must be either business or investment prop- erty. Cash and other non-quali- fied property (principal and secondary residences) cannot be included as part of the ex- change, otherwise it will result in a partially or potentially fully taxable transaction. Because investors can rarely, on their own, effectuate a direct exchange, IRS requires the seller in a deferred exchange to use an independent third party to facilitate the transac- tion. This facilitator is known as a qualified intermediary (QI). The QI allows for the real estate owner to complete
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