Essential Knowledge for Essential Knowledge for Tax Deferred ExchangeTax Deferred ExchangeEssential Knowledge for Essential Knowledge for Tax Deferred ExchangeTax Deferred Exchange

Jason Pastucha, REALTOR 2008Jason Pastucha, REALTOR 2008

jasonp@kw.comjasonp@kw.com

Tax Deferred Gains in ExchangeTax Deferred Gains in Exchange The payment of capital gains and recapture of depreciation The payment of capital gains and recapture of depreciation

taxes are indefinitely deferred in a qualifying 1031 exchange.taxes are indefinitely deferred in a qualifying 1031 exchange.

BASIS

Purchase Price

Sales Price

CAPITAL GAIN (15% TAX)

RECAPTURE (25% TAX)DEPRECIATION

ADJUSTED BASIS

TIME

GAIN

IRC Section 1031IRC Section 1031

No gain or loss shall be recognized on the No gain or loss shall be recognized on the exchange of property held for productive exchange of property held for productive useuse in a trade or business or for in a trade or business or for investment if such property is investment if such property is exchanged exchanged solely for property of like kindsolely for property of like kind which is to which is to be held either for productive use in a trade be held either for productive use in a trade or business or for investment.or business or for investment.

Exchange RequirementsExchange Requirements 1. The properties exchanged must be for 1. The properties exchanged must be for

business use or held for investment.business use or held for investment. 2. The taxpayer must not get actual or 2. The taxpayer must not get actual or

constructive receipt of proceeds.constructive receipt of proceeds. 3. Use of a Qualified Intermediary qualifies 3. Use of a Qualified Intermediary qualifies

the exchange for Safe Harbor protection.the exchange for Safe Harbor protection. 4. 45 Day Identification and 180 Day 4. 45 Day Identification and 180 Day

exchange closing time requirements.exchange closing time requirements. 5. Total deferment of taxable gain in an 5. Total deferment of taxable gain in an

exchange requires a trade “up or equal” in exchange requires a trade “up or equal” in both Equity and Fair Market Value.both Equity and Fair Market Value.

Exchange PartiesExchange Parties

QI is assigned Exchanger’s contract rightsQI is assigned Exchanger’s contract rights

Qualified IntermediaryExchanger

Buyer Seller

Sale Proceeds

Purchase Funds

Contract Rights

Title In

Title Out

Qualified Intermediary Safe HarborQualified Intermediary Safe Harbor

QI holds funds from sale for purchase of QI holds funds from sale for purchase of replacement property.replacement property.

QI prevents constructive and actual QI prevents constructive and actual receipt of sale proceeds by Exchanger.receipt of sale proceeds by Exchanger.

Exchange Agreement establishes the legal Exchange Agreement establishes the legal relationship between QI and Exchanger.relationship between QI and Exchanger.

*Exchanger’s contract rights assigned to QI*Exchanger’s contract rights assigned to QI

Exchange Time RequirementsExchange Time Requirements

45 Day Identification Period

180 Day Exchange Period

The 45 day identification and the 180 day acquisition timelines

both begin on the closing of the sale of relinquished property

Non-simultaneous=Relinquish and Replacement

““BUY to HOLD” = ExchangeBUY to HOLD” = Exchange

Intent at time of exchange controls.Intent at time of exchange controls. Investors buy with intent to hold property Investors buy with intent to hold property

for income and appreciation benefits.for income and appreciation benefits. ““Buy to Sell” Dealer transactions do not Buy to Sell” Dealer transactions do not

qualify for 1031 Tax-Deferral.qualify for 1031 Tax-Deferral. Pattern of regular, frequent, and Pattern of regular, frequent, and

continuous sales indicate “Dealer” status.continuous sales indicate “Dealer” status. Properties held for less than two years Properties held for less than two years

appear more like “Dealer” property.appear more like “Dealer” property.

Tax Deferred in 1031 ExchangeTax Deferred in 1031 Exchange

BASIS

$30,000

$50,000Purchase Price

$150,000 Sales Price

CAPITAL GAIN (15% TAX)

RECAPTURE (25% TAX)DEPRECIATION

ADJUSTED BASIS

$100,000

$70,000

$80,000 Gains are Tax Deferred, $30k Recapture + $50K CapGains *Deferring payment of $15,000 in taxes

Time

Deferment of Taxable GainDeferment of Taxable Gain

RuleRule – To totally defer taxable gain in – To totally defer taxable gain in an exchange, taxpayers must trade an exchange, taxpayers must trade up or equal in both Equity and Fair up or equal in both Equity and Fair Market Value.Market Value.

AlternativeAlternative – Mortgage relief or cash – Mortgage relief or cash received is taxed to the extent of the received is taxed to the extent of the gain realized (cash added offsets gain realized (cash added offsets mortgage relief).mortgage relief).