Introduction to Reverse 1031 Exchanges Pursuant to IRS Revneue Procedure 2000-37

Introduction to Reverse 1031 Exchanges Pursuant to IRS Revneue Procedure 2000-37
Investors can acquire a like-kind replacement property before disposing of the current relinquished property by structuring a reverse 1031 exchange transaction pursuant to Revenue Procedure 2000-37. Investors may be concerned about the possibility of not being able to locate, identify and acquire suitable like-kind replacement properties within the required deadlines …

Pros and Cons of 1031 Exchange
Pros of 1031 Exchange:
The taxpayer may dispose of property without bringing upon oneself any immediate tax liability. This allows the taxpayer to keep the earning power of the deferred tax dollars working for him in another investment. In effect, this money can be considered an interest-free loan from the IRS. There is no interest paid on the outstanding loan balance and there is no specific due date.

The loan will be abolishing upon the death of the taxpayer, which means that the taxpayer's estate never has to repay the loan. The taxpayer who is entitled by law gets a stepped-up basis on inherited property; that is, their basis is the fair market value of the inherited property at the time of the taxpayer's death. A subsequent sale by the heirs will be taxable only to the extent of the difference between the stepped up basis and the net sale price.

1031 exchange is highly advantageous to the taxpayer as it enables the taxpayers to sell income, investment or business property and replace with like kind replacement property without having to pay the capital gain taxes on the transaction. Section 1031 of IRS is the basis of tax-deferred exchanges. The ?safe-harbor? Regulations was issued by the IRS in 1991, which established approved procedures for 1031 exchanges. With the issue of this regulations tax deferred changes became easier, affordable and safer than before.

Cons of 1031 exchange:
The main disadvantage of 1031 exchange is that it offers a reduced basis for depreciation in the replacement property. The tax on the replacement property is calculated on the basis of the purchase price of the replacement property minus the gain, which was deferred on the sale of the relinquished property as a result of the exchange. Thus the taxpayer needs to pay tax also on the deferred gain if he cashes out of his investment.

The taxpayer may incur increased transactional costs for entering into and completing an Exchange. Typical costs include possible additional escrow fees, attorney's fees, accounting fees, and the Qualified Intermediary's fees.
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1031 Exchange Rules and Requirements
A property transaction can qualify for a deferred exchange only if it follows the 1031 exchange rules laid down in the tax code and the treasury regulations. The foundation of 1031 exchange rules are that the properties involved in the transaction must both be held for productive purpose in trade, business and investment.

The 1031 exchange rule also lays down a guideline for the proceeds of a sale. The proceeds from the sale must go through the hands of a qualified intermediary and not by the hands of one of your agents or else all the proceeds will become taxable. The entire cash proceed from the original sale must be reinvested towards acquiring the new property. Any cash proceeds from the sale, if retained, are taxable.

The rule requires that the replacement property must be subject to an equal or greater level of debt than the property sold or the buyer will have to pay the tax on the amount of decrease or he will have to put in additional cash to offset the low debt amount on the newly acquired property.

There are two timelines that must be followed for a 1031 exchange to be successful.

Identification Period
This is the period during which the party selling the property must identify other replacement properties that he proposes to buy. It is scheduled as 45 days from the day of selling the relinquished property. The 45 days timeline has to be followed under any and every circumstances and is not extendable even if the 45th day falls on a Saturday, Sunday or any legal holiday.

Exchange Period
This is the period within which the person who has sold the relinquished property must receive the replacement property. It ends at 180 days after the date on which the person transfers the property relinquished or the due date for the person's tax return for the taxable year in which the transfer of the relinquished property occurred. According to 1031 exchange rule about timelines this 180 day timeline has to be adhered to under any circumstances and is not extendable even if the 180th day falls on a Saturday, Sunday or any legal holiday.
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How do I perform a 1031 exchange?

There are six basic steps in a 1031 exchange. Scores of small jobs take place within each of these steps, but this list of steps can at least help you understand the basic timetable.

Step One: Identify selling property. You may already have a property in mind that you want to sell. On the other hand, you may receive an offer you can't refuse, or you may just wake up in the middle of the night eager to unload a property.

Step Two: Contact the right parties. You'll need to hire a qualified intermediary to run the 1031 exchange for you and to hold the proceeds from the sale. In addition, you'll want to contact your attorney, CPA, and real estate agent.

Step Three: Find a buyer and write a contract. Your intent to perform a 1031 exchange doesn't impact the buyer, but the contract should have specific language proclaiming your intention to perform an exchange.

Step Four: Sell the property. At the closing, the contract should list your qualified intermediary as the seller, and all the sale proceeds will go into his trust.

Step Five: Find your new property. Per IRS guidelines, you have forty-five days to identify up to three potential replacement properties, and within 180 days, you must close on the new property.

Step Six: Purchase the new property. Notify your intermediary of your intent to purchase property and, at the closing, he will transfer the proceeds from the first sale to the seller of your new property.

Fortunately, intermediaries are very experienced in performing 1031 exchanges. They do most of the paperwork and guide you through the process; your primary jobs are identifying the properties and giving the go-ahead.

What is a 1031 exchange?

A 1031 exchange (also called a Starker, like-kind, or tax-free exchange) occurs when an investor sells property and then uses the sale proceeds to purchase a similar piece of property–in essence, "exchanging" one property for another. If you adhere to IRS regulations regarding this transaction, you can defer all of the tax on the sale of the property.

Normally, the IRS requires that you pay taxes on your gain from the sale of property, but regarding a 1031 exchange, the IRS declares that no funds are actually generated by the sale. Thus, there is only a "paper gain," which the IRS will not tax, and until you can defer the tax indefinitely until you sell the property for cash.

1031 exchanges are potentially very lucrative, but the IRS does restrict their operation. You have to follow a strict timetable and allow a neutral part to hold the sale proceeds in the time between the sale of the first property and the purchase of the replacement property. In addition, you can only exchange investment and income-producing property of like kind. Even with these restrictions, however, thousands of businesses and individuals have benefited from 1031 exchanges.

1031 Timelines
Identification Period: Within 45 days of selling the relinquished property you must identify suitable replacement properties. This 45 day rule is very strict and is not extended should the 45th day fall on a Saturday, Sunday, or legal holiday.Exchange Period: The replacement property must be received by the taxpayer within the "exchange period," which ends within the earlier of . . . 180 days after the date on which the taxpayer transfers the property relinquished, or . . . the due date for the taxpayer tax return for the taxable year in which the transfer of the relinquished property occurs. This 180-day rule is very strict and is not extended if the 180th day should happen to fall on a Saturday, Sunday or legal holiday.
If you are considering a 1031 exchange please visit http://www.1031-nnn-properties.com/ for more in depth information on 1031 exchanges or to speak with an investment specialist about acquiring triple-net properties.

About the Author:

Jeff Peterson (AKA: "Professor 1031") is a Qualified Intermediary and Serves as an Adjunct-Professor for the William Mitchell College of Law (Where He Teaches About Federal Income Tax). Jeff Works With People From All Over the USA to Save Money on Federal Capital Gains Taxes.

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