If you exchange real estate is held for business use or investment, you can possibly qualify under the Internal Revenue Code 1031 for a non-taxable like-kind exchange. The property you receive is treated as if it were a continuation of the property you gave up. By following the rules and safe harbors of Regulation 1031, you may even qualify a delayed exchange which has become more prevalent today when exchanging real property.

In a like-kind exchange, you do not recognize gain from the like-kind property you receive. But you do recognize gain if you also receive money or other property. Money and other property received, including installment notes, is called boot. IRS uses the term "deferred exchange" to define what most real estate exchangers call a "delayed exchange." The IRS defines a "deferred exchange" as an exchange in which, pursuant to an agreement, the taxpayer transfers relinquished property and subsequently receives replacement property.

Purpose: In exchanging, the single most important issue is intention to complete a transaction as a IRC 1031 exchange. Documents preserve that intention and assure that the expectation of the parties is attained when one property is released to the other party long before escrow can be closed.

IRC 1031 liberally permits all variety of structuring which two people might arranged to meet problems created by mortgage financing, cash requirements, title, construction, third party owners, escrow needs, and such things as time to locate like kind property.

Rarely do two people own property which they both would exchange with each other. One or the other wants other property than what is offered. Hence, a search begins to locate other like kind property. That search must be prudent in a continuing investment program. Frequently, it requires more time than normally desired for escrowing. That is, one party wants to close out one leg of the exchange before the other leg can be located.

Thus, a delay must occur in the delivery of the yet-to be-located property. Deeds will be delivered non-concurrently. No simultaneous deeding can occur because of the inability to yet locate and identify the specific like kind property to be delivered up to the taxpayer-exchange. Hence, an open-ended escrow period is utilized to close out one leg of the exchange and await the deeding of the yet-to-be- located property so exchange escrow can be closed. However, strict time limits apply.

Basis of Property Acquired: 1031 exchanges are not "tax free." These exchanges merely postpone recognition of taxable gain until some future date when the property is ultimately sold.

When the property is sold, the taxable gain is the difference between the selling price of the property and its basis. DISCLAIMER: discuss the tax ramifications with your accountant, CPA or attorney. Re/Max South County, their agents, or Carl Mitrak are not responsible for any material used herein as to reliability of content.

Gain (Loss) Realized: Gain realized is an economic concept indicating the amount of gain actually experienced in the transaction. Gain realized is the profit on the deal. In contrast, gain recognized is the gain reported for tax purposes. Fair Market Value of Property Received: property received in a 1031 exchange must be " like-kind" property held for use in a trade or business or held for investment. Property may exchange in one of four ways: Investment property for investment property; Investment property for trade or business property 3.Trade or business property for investment property; and 4.Trade or business property for trade or business property Section 1031 does not include inventory, shares of stock, bonds, notes, certificates of trust or beneficial interest, and any other securities or evidences of indebtedness or interest. Debt Relief. The amount of net debt relief that the taxpayer received by transferring his old property subject to existing encumbrances is also boot. When debt relief is smaller than the amount of gain realized, only the amount of gain realized is taxable. The general rule is that the transaction is taxable on the lesser of gain realized or boot received. Debt relief is treated the same as money received on the exchange

1031 Exchange Clauses: (Purposes-Three Basic Exchanges) 1.Simple Exchange 2.Exchange with Resale 3.Exchange Delayed The Clause: It is the intention of both parties hereto that this exchange as a tax deferred exchange under Section 1031 of the Internal Revenue Code.
1031 Terms:

1. BOOT is created when the "Target Property" mortgage is less than the mortgage on the "Exchange Property
   
2. Mortgage Relief occurs when the " Target Property" mortgage is less than the mortgage on the "Exchange Property" which creates Boot, a taxable event.
   
3. The "Exchange" must have held the "Exchanged property" as an Investment or within their business or trade in which the "Exchange has taken appropriate deductions on the 1040 Form.
   
4. The "Exchange" must trade for "Like for Like-kind" properties that are designated as "Realty", and this does not mean "Same". The following are "ALL REALTY": Land ( improved or not ), Office Building, Commercial, Industrial, Vacation house, Apt., 30 + year leases, House(s) Any mix is available = Both Ways.
   
5. In a typical deferred exchange you transfer the relinquished property to a qualified bonded intermediary who promises to acquire replacement property and transfer ownership.
   
6. The " Facilitator" (Intermediary, Strawman, Accommodator) must be an Independent third party not under any control of the " Exchange" either actually or constructively.
   
7. Cash paid by "Exchangor" toward the "Target Property" reduces mortgage relief (Boot), and increases Basis.
   
8. The "Exchange" must be completed within the same calendar year. If you carry forward into the subsequent year, do not file your 1040 Form until you have closed- file and extension. Tax filing is the same as the 180 day of the "Exchange".
   
9. Upon the closing of the "Exchange Property" the "Exchangor" has 45 days from the day after the close of the "Exchange Property(ies)" to designate the "Target Property (ies) " which MUST close within 180 days from the "Exchange Property" closing. NOTE: The 180 days includes the 45 days.