1031 Exchanges

1031 EXCHANGES

Section 1031 of the Internal Revenue Code allows the owner(s) of certain property to defer federal taxes associated with gain or loss on the sale of such property by acquiring qualified similar property. In large real estate transactions, investors can realize very substantial tax savings. This method allows your investment to continue to grow tax deferred. 1031 exchanges are subject to strict time and money handling requirements. For example, to complete a proper 1031 exchange, it is crucial that the proceeds from the first sale be given to a qualified intermediary, that replacement properties be identified in a specific fashion, and that all proceeds be accounted for on both transactions.


A 1031 exchange offers a great opportunity for a person to avoid paying taxes on the sale of property that he or she intends to rollover into a new property. However, there are multiple requirements and conditions that must be met in order to reap this benefit and avoid severe tax consequences in the future. It is very important to have the guidance and legal expertise of qualified New York 1031 exchange attorneys. The attorneys at Kokolakis Law Firm have represented a multitude of clients in 1031 exchanges. Our law firm is highly focused in this unique area of real estate law. By completing a proper 1031 exchange, you can essentially change the form of your investment without cashing out or recognizing any capital gains. Schedule a consultation today to speak with 1031 Exchange Attorneys in Queens, NY and Astoria, NY.

General Information:

  • WHAT IS A 1031 EXCHANGE? WHAT DOES IT DO?

    Often described as one of the best real estate investing methods for preserving and building real estate wealth, a 1031 exchange is a transaction that allows a taxpayer to defer the capital gains tax that would be due in the sale of an asset. Essentially, it permits an investor to reinvest the proceeds from a sold property into a new property of the like, with the intent to defer capital gain taxes that would otherwise be due in a sale of the original property. The investor now has extra funds that may be applied to the new property that otherwise would have gone towards capital gains taxes.


    A successful 1031 exchange must meet the strict rules found in Section 1031 of the Internal Revenue Code. On its face the premise of a 1031 sounds simple but It is imperative that an investor is well advised in the exchange process and Section 1031 of the IRC code in order to avoid costly mistakes and avoid missed opportunities.


    What Is A Capital Gain?


    A capital gain is the profit realized from selling a capital asset such as real property. When a capital asset is sold and the the sale price exceeds the purchase price the difference between the amount you paid for the asset and the amount you sold it for is the capital gain. The United States of America imposes a tax on the net total of all the capital gains of individuals and corporations.


    Capital gains are divided into two categories: Short term capital gains which are taxed at the investor’s ordinary income tax rate and are defined as investments held for a year or less before being sold and Long-term capital gains which are taxed at a lower rate on dispositions of assets held for more than one year.


    What Type Of Property Qualifies For A 1031 Exchange: What is a Like-Kind Property?


    The replacement property in a 1031 exchange must be of like-kind property to the relinquished property and and must be held for business or investment purposes. The IRS is liberal in defining like-kind property in that it refers the words “like-kind” to the nature or character of the property, not its grade or quality. Thus, real property is not of like-kind to personal property because they are of a different nature and character but most types of real estate can be exchanged for other real estate regardless of whether the properties are improved or unimproved. Therefore, an exchange of a hotel for an office building or an office building for a shopping center or a condo unit for a warehouse or Commercial property for unimproved property or an industrial building for a multi-family property or any combination of the foregoing are examples of qualified 1031 like-kind properties because they are of like-kind with respect to their intrinsic nature and character and may, therefore, be interchangeably exchanged.


    The location of the properties is taken into consideration as well. Like-kind property must be located in the United States or the U.S. Virgin Islands. Foreign real estate is not considered like-kind property for the purposes of a 1031 exchange.


    What Types of Property Do Not Qualify For A 1031 Exchange?


    Not all property qualifies for 1031 exchange treatment. Section 1031 does not apply to exchanges of:

    • Inventory or stock in trade
    • Stocks, bonds, or notes
    • Other securities or debt, accounts receivables
    • Partnership interests
    • Certificates of trust
    • Personal residence unless converted into an investment property which we will touch upon below.

    Can A Replacement Investment Property Be Converted Into A Primary Residence?


    An investment property can be converted into a primary residence. However, this must not be done right away nor should there be any intent to convert the property to a primary residence during the 1031 exchange. Sometimes life happens, unforeseen events, not related to the 1031 exchange may occur such as the property generating a negative cash flow or the death of a spouse that makes it necessary to convert the investment property to a primary residence. Generally, the investment property must be used as an investment property for a certain number of years following the purchase in order for the IRS to not challenge whether the rental property qualifies as property held for productive use in a trade, business or for investment.


    Not only may an investment property be converted but if done correctly the conversion to a primary residence may yield additional tax savings above those gained by the 1031 exchange.


    Converting rental property acquired in a 1031 exchange to a primary residence now allows us to combine Section 1031 with Section 121 which provides for $250,000 ($500,000 for certain married taxpayers) exclusions provided the investor lives in the property for an aggregate of 2 of the preceding 5 years. Combining the 1031 exchange and the 121 exclusion on the sale of real property is a brilliant tax planning strategy that potentially qualifies the investor to eliminate certain gains resulting in substantial savings for the savvy investor.


    For more information on 1031 Exchange in New York, a free initial consultation is your next best step. Get the information and legal answers you are seeking by calling (718) 444-1000 today.

  • CAN A PRIMARY RESIDENCE BE CONVERTED INTO AN INVESTMENT PROPERTY?

    A primary residence is not considered a like-kind property and, thereby, does not qualify for 1031 exchange treatment. However, a primary residence can be converted into an investment property. In recent times, it is not uncommon for a primary residence to eminently appreciate in value. Such a high appreciation places the primary resident owner in a situation where their capital gain significantly exceeds the tax re-exclusion limitation of the 121 exclusion.


    When faced with this scenario, it is wise to consider converting the primary residence to an investment property. Generally, this is achieved by moving out of the primary residence and renting it out for a certain amount of time. Upon correctly following the required steps, the investment property is now sold. The first $250,000 or $500,000 for certain married taxpayers would be tax-free under Section 121 and the balance of the capital gain and depreciation recapture would be deferred by completing the 1031 exchange.


    What Is Depreciation Recapture?


    The IRS permits the depreciation of real property over time with such allowance taken as a deduction against income tax. Upon the sale of the real property at a gain, the IRS utilizes a procedure known as depreciation recapture to collect income tax on the gain realized by the taxpayer, when the taxpayer sold the real property that had previously provided an offset to ordinary income for the taxpayer through depreciation. In other words, if an investor disposes of depreciable property at a gain, they may have to treat all or part of the game as ordinary taxable income. It is prudent to keep permanent records of the facts necessary to figure the depreciation or amortization allowed or allowable on your property to ascertain any gain that must be reported as ordinary income.


    Who Can Qualify For The 1031 Exchange?


    Individuals, C corporations, S corporations, partnerships (general or limited), limited liability companies, trusts and any other taxpaying entity who are owners of investment and/or business property may qualify for a Section 1031 deferral and accordingly set up an exchange of business or investment properties for business or investment properties under Section 1031 of the Internal Revenue Code. Basically, the regulations with regard to who can perform a 1031exchange and what can be exchanged are fairly broad, but there are time restrictions for a 1031 exchange that must be strictly followed.


    What Are The Time Restrictions For A 1031 Exchange?


    The IRS imposes specific and strict time restrictions that must be met in order to successfully complete a 1031 exchange. These are referred to the identification period and the exchange period.


    What is The Identification Period?


    The Internal Revenue Code imposes the identification period which requires the replacement property to be identified within forty-five days from the closing of the sale of the relinquished property. Therefore, the investor must identify like-kind replacement properties they are considering for acquisition in their 1031 exchange no later than midnight of the forty-fifth calendar day following the closing of their relinquished property. The forty-five days are based on calendar days and not extended if the forty-fifth day falls on a Saturday, Sunday or a legal holiday. No extensions are allowed under any circumstances. Furthermore, when identifying the replacement property, the investor must follow certain identification rules.


    What is The Exchange Period?


    In addition to the identification period, Section 1031 requires that the purchase and closing of the replacement property occur by the one hundred and eightieth day of the closing of the relinquished property. This is referred to as the exchange period and runs concurrently with the forty-five day identification period. Not unlike the forty-five day identification period, the one hundred eighty day deadline has to be adhered to under all circumstances and is not extendable in any situation even if the one hundred eightieth day falls on a Saturday, Sunday or legal U.S. holiday. It is important to note that although the one hundred eightieth day exchange period cannot be extended, it can, under certain circumstances, be shortened.


    For more information on Residences & Investment Properties, a free initial consultation is your next best step. Get the information and legal answers you are seeking by calling (718) 444-1000 today.

  • WHAT ARE 1031 EXCHANGE IDENTIFICATION RULES?

    During the forty-five day identification period, the investor must provide an unambiguous description of the replacement property, by following one of three identification rules on or before the forty-fifth day after closing on the relinquished property.


    The first rule is known as the Three Property Identification Rule. This rule permits the investor to identify up to three properties of any value with the intent of purchasing at least one. The investor may purchase all three of the identified like-kind placement properties as part of their 1031 exchange or simply intend to purchase one of them with the second and third identified properties as backup like-kind replacement properties, in case the first property cannot be purchased.


    The Two Hundred Percent of Fair Market Value is the second identification rule. Utilizing this rule, the investor may identify more than three properties with an aggregate value that does not exceed two hundred percent of the market value of the relinquished property. This rule does not limit the total number of like-kind replacement properties.


    The third and last identification rule is known as the Ninety-Five Percent Identification Exception. The investor, under this rule, may identify more than three properties with an aggregate value exceeding two hundred percent of the relinquished property, knowing that ninety-five percent of the market value of all properties identified must be acquired. This rule also does not limit the total number of like-kind replacement properties provided that the investor actually purchases and closes on ninety-five percent of the value identified. If, however, the investor does not purchase and close on at least ninety-five percent of the value of the identified like-kind replacement properties, then the entire 1031 exchange transaction fails.


    In What Circumstances Can The 180 Day Exchange Period Be Shortened?


    It is possible for the one hundred and eighty day exchange period to be shortened to less than 180 days. The exchange period is shortened if the due date of the investor’s tax return for the taxable year in which the transfer of the relinquished property occurs before the one hundred eighty days. This may be avoided by filing for an extension. Thus, it is important for the investor to not file a tax return if it becomes due prior to the one hundred eighty days and to file for an extension which would result in extending the exchange period to the full one hundred eighty days.


    Should Someone Reinvest Only The Net Equity?


    What first must be considered is whether or not someone wishes to defer all capital gain taxes and/or depreciation recapture taxes, which would be the 1031 exchange, or just some of the income tax liability, which will be considered a partial 1031 exchange. The former would require investing the entire net sales price whereas the latter would be considered a partial 1031 exchange and would result in some tax liability. Notice the term net sales price and not net equity is used.


    Focus should be placed on the net sales price and not the net equity because the net sales price takes into consideration closing costs which may be deducted from the sales price in figuring the gain or loss on the sale providing an accurate indication of the actual net.


    Basically, there is no requirement to reinvest the net equity, doing so however, will defer all capital gain taxes and recaptured depreciation taxes.


    How Does An Earnest Money Deposit Affect A 1031 Exchange?


    In the real estate and 1031 exchange context, the earnest money deposit is a deposit that accompanies the contract of sale to demonstrate the buyer’s commitment and to bind the contract. Even though the investor is attempting to complete the second leg of the 1031 exchange by purchasing the replacement property we are still dealing with regular sale and for the most part it should be treated as such.


    The earnest money deposit may be sourced from the exchange proceeds received from the relinquished property provided certain extra requirements are satisfied or from the investor’s personal funds. It is highly recommended, however, that personal funds are used. The rationale behind this recommendation derives from our focus on the relinquished property and the possibility that the investor does not close on the replacement property. Let us assume for the moment that the closing for the replacement property does not occur and the earnest money deposit is returned. If these funds were from the exchange proceeds then they cannot be returned to the investor.


    The investor, upon relinquishing the property during a 1031 tax deferred exchange is prohibited from directly handling the proceeds from the sale of the relinquished property. Doing so may be deemed as the investor being in constructive receipt of the proceeds and negating the 1031 exchange resulting in having to pay all capital gain taxes on the relinquished property. The investor is permitted to receive their personal funds as they are not part of the exchange funds. Thus, the prudent investor cautiously uses personal funds in the event the need arises to have their earnest money deposit returned.


    For more information on 1031 Exchange Identification Rules, a free initial consultation is your next best step. Get the information and legal answers you are seeking by calling (718) 444-1000 today.

  • WHAT IS CONSTRUCTIVE RECEIPT?

    To successfully complete a 1031 tax deferred exchange Investors must exchange the relinquished property for the replacement property. In doing so the investor must make sure that they are at no time in “constructive receipt” of the sales proceeds.


    As it relates to the 1031 exchange, constructive receipt refers to the investor/taxpayers unrestricted access to money or property. Actual possession of the money or property is not required. Therefore, irrespective of whether or not there is actual physical receipt of the money or property, the mere fact that the money is credited to, set apart for or otherwise made available to the Investor/Taxpayer deems the Investor/taxpayer to have constructive receipt of the money or property causing that money or property to be taxable. To avoid “constructive receipt” of the sales proceeds, a neutral party, such as a qualified intermediary, is often used to maintain the sales proceeds out of the reach of the taxpayer.


    What Is A 1031 Qualified Intermediary?


    One of the rules of 1031 Exchange is the necessity of preventing the investor from being in “constructive Receipt” of the exchange proceeds because doing so jeopardizes the 1031 Exchange and may create the need to have to pay the capital gains tax on the sale in the same year, rather than defer the capital gains. The role of the Qualified Intermediary is, among other things, to prevent the investor from being in “constructive Receipt” of the exchange proceeds.


    A 1031 Qualified Intermediary, also known as an Accommodator, intermediary or facilitator, is a company that is in the full-time business of facilitating Internal Revenue Code section 1031 tax-deferred exchanges. The Qualified Intermediary does not provide legal or specific tax advice to the exchanger/investor.


    Can The Replacement Property Be Purchased From A Family Member?


    In most cases, you are not able to acquire your replacement property from a related party without violating the IRS related party rules and guidelines resulting in depreciation recapture and capital gain income tax liabilities.


    However, in this case we do have a few exceptions. Attempting to complete a 1031 exchange by purchasing the replacement property from a relative may be accomplished if the investor’s relative is also completing their own 1031 Exchange transaction using the sale proceeds from the purchase. Another exception would be proving to the IRS that the transaction did not result in an income tax basis swap.


    Can Someone Relinquish Their Old Property To Be Sold To A Family Member?


    This is a bit tricky in that selling the relinquished property to a relative may trigger tax basis swapping which may not be looked upon as favorable by the IRS. Basically, the IRS frowns upon using a relative to establish a higher basis in a low basis property through a 1031 exchange. This is not to say that it cannot be accomplished. In order to complete a successful 1031 deferred exchange by selling to a relative, the investor would need to sell the relinquished property to a relative but the relative must hold the property for no less than two years. To further complicate matters, the investor must also hold the thereafter purchased replacement property for no less than two years. The two (2) year holding period starts running on the date of the transfer or conveyance of the last property involved in the 1031 Exchange related party transaction.


    What Is A Related Party?


    The definition of related parties is a combination of related parties as defined pursuant to Sections 267(b) and 707(b) of the Internal Revenue Code.


    Related parties include, but are not limited to, immediate family members, such as brothers, sisters, spouses, ancestors and lineal descendents. Related parties do not include stepparents, uncles, aunts, in-laws, cousins, nephews, nieces and ex-spouses.


    Moreover, Corporations, limited liability companies or partnerships in which more than 50% of the stock, membership interests or partnership interests, or more than 50% of the capital interests or profit interests, is owned by the taxpayer is considered to be a related party.


    For more information on Constructive Receipt in New York, a free initial consultation is your next best step. Get the information and legal answers you are seeking by calling (718) 444-1000 today.

  • WHY SHOULD I CONSIDER A 1031 EXCHANGE WHEN SELLING AN INVESTMENT PROPERTY?

    The astute investor understands the many benefits in a 1031 exchange. They understand that a 1031 exchange permits the preservation of investment capital by deferring payment of capital gains taxes translating to stronger buying power, greater appreciation and greater profits.


    The 1031 exchange should be considered a valuable tool by investors seeking to sell an underperforming asset and acquire an asset that offers a more attractive cash flow or appreciation potential without immediately paying any capital gains taxes. Capital gains tax is not due until the investor sells the Replacement Property without utilizing a 1031 Exchange. However, since there is no limit to the number of exchanges the investor can complete, it is possible to defer the payment of tax indefinitely. The compounding effect of earning a continual return on all of the equity with each 1031 exchange, instead of a portion of the equity, can result in a higher overall yield for the investor. This preservation of equity via tax-free exchanging is a powerful wealth building tool.


    What Sets Your Firm Apart In Handling 1031 Exchanges?


    A 1031 exchange may sound simple in premise but we do not take these transactions lightly. We believe in the necessity of advanced planning when considering a 1031 exchange. We emphasize time and time again to our clients that we must specifically follow the rules for 1031 exchanges or we risk being liable for taxes, penalties, and interest.


    Knowing to follow the rules is merely the beginning. Section 1031 exchanges are technical, complex and evolve as U.S. tax laws continually change. We serve our clients by carefully guiding them through the exchange, answering their questions and making sure we are updated with the ever changing tax laws.


    However, we do not stop there! We make sure to add that extra something that goes above and beyond just successfully handling the 1031 exchange. This extra something is what we call value. We strive to have our clients feel the value we provide; realize the benefits of our services. We aren’t merely legal counselors but at times assume the role as business advisors as we work together strategizing the 1031 exchange adapting to our clients needs.


    We make sure that every one of our clients receives the special attention they deserve. This comes with truly caring as we service our clients. They aren’t just another case file but rather a new member of our family.


    Simply put, it’s all about an experience; one that has no equal. It’s different. Join us and experience our difference. Call to schedule your personal 1031 exchange strategy session today.


    For more information on Selling an Investment Property, a free initial consultation is your next best step. Get the information and legal answers you are seeking by calling (718) 444-1000 today.

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