TEN SECRETS – 1031 EXCHANGE

TOP TEN SECRETS OF 1031 EXCHANGES

• The first secret is using a Qualified Intermediary or QI to perform 1031 Exchange Professional services, escrow and paperwork doesn’t cost much – about $1000 – $2000 per “round trip” i.e. 1 RQ (relinquished property) and 1 RP (replacement property) – where the property being relinquished is RQ and the property being purchased is the replacement or RP. For each subsequent RP, the fees could be as low as $400, per RP.

• Weigh this against the possible penalties of a 1031 exchange gone awry:  income tax pursuant to the sale of the RP, PLUS the penalty and interest imposed on the underpayment of tax, equal to the federal funds short term rate plus 3%. Another – the accuracy penalty – is 20% of the substantial understatement of the tax. (A substantial understatement is the greater of $5,000 or 10% of the recognized gain.) Another, a fraud penalty may be imposed of 75% of the underpayment if it is determined that investor’s intent was to evade the tax.  Also, S 6701 levies penalties if anyone assists in the preparation of the investor’s return knowing that this help may result in an understatement of tax. A $1,000 – $10,000 penalty is possible, here.

• Little known fact: all exchange documentation must be filed prior to settlement of the RP. This prevents constructive receipt and proves intent.

• The investor a.k.a. Taxpayer (TP) must never have actual or constructive receipt of exchange funds, rather the QI will manage escrow and wiring funds prior to settlement.

• The taxpayer that sells must be the taxpayer that buys. If the wife sells and then both husband and wife buy jointly, the exchange is partial.  However, it is ok if the wife sells a RQ, and buys the RP via a SMDLLC – single member disregarded LLC.

• Allowable Exchange Expenses (AEE) are those expenses that pertain directly to the exchange transaction such as broker fee, exchange fee, transfer & record fees etc. Property operation expenses are NOT allowable e.g. condo fees, taxes, insurance etc.  (AEE can be added to the purchase price of the RP to increase the taxable basis of the RP!)

• To properly qualify for use in a 1031 Exchange, a Qualifying Property must be held for Qualifying Purpose.  Law disqualifies TP residence, stock in trade, stocks, bonds, notes, securities, interests in entities, resale property, dealer property, flips etc., generally, based on time owned. Qualified property could include: home office, vacation homes for investment, etc.

• 45 Days are allowed by statute, after settlement of the RQ, within which a TP files to narrow choice of RP and comply with either of 3 RULES: 3 property rule – identify 3 properties regardless of value, or 200% rule – 200% of the Fair Market Value of the RQ, for any number of properties, or the 95% rule. RP List cannot be changed after Day 45, closed on or not.  Further, the identified RP must also meet “Trade Up/Trade Even” tax rules.

• RP must be “like-kind” – basically any real estate is ok, as long it fulfills Qualifying Purpose definitions.

•  Identified RP must be closed on before midnight on Day 180 from RQ settlement date, or when tax return is due, including extensions.