by Alyson S. Repp, Esq
On Tuesday November 18th the Suffolk County Women’s Bar Association held their annual East End event at the lovely Dark Horse restaurant in Riverhead. The guest speaker was Eric Brecher, Esq. of City National Bank 1031 Exchange Services and a Certified Exchange Specialist. Fortitude Investment Group, who specializes in IRC 1031 Exchange Transactions, graciously sponsored the event. Those who attended will receive 1 Professional Practice CLE credit (approval pending).
The night started out with a cocktail hour and passed hors devours during which arriving participants chatted with the sponsors and guest speaker. The CLE itself was very informative especially for those who are not familiar with the basic 1031 deal and process. Mr. Brecher provided a great handout which contains invaluable information for those looking to break into this area of law. As a real estate attorney actively practicing in the area of 1031 exchanges I found the speaker and presentation very relevant and a wonderful addition to my knowledge base. The representatives from Fortitude ended the evening by explaining the services they provide which include helping your client identify properties to exchange. Below is a little information regarding the 1031 exchange process.
Generally, when you sell a commercial property, you pay capital gains tax on any gain you realize at the time of the sale. Section 1031 of the Internal Revenue Code provides an exception to this rule, allowing you to postpone or defer paying the tax if you reinvest the proceeds you have gained from the sale into a similar property under an IRS qualifying like-kind exchange.
Although not the only kind of exchange or tax saving method, there are three types of exchanges which real estate investors frequently engage in. The most simple and straightforward is known as a simultaneous exchange. In a simultaneous exchange, property A is sold and property B is purchased simultaneously. The funds obtained from the sale of property A are used to purchase property B. In order to avoid paying capital gains tax on the purchase and deferring the payment of the tax, you must invest all the funds gained in the sale of property A into property B. Any funds remaining at the end of the exchange may be immediately taxable.
The second type of exchange is considered a deferred exchange. In a deferred exchange, property A is sold (the “Relinquished Property”) and then, within a certain period of time, respectively known as the 45-Day Clock and the 180-Day Clock, you must use those funds to purchase property B (the “Replacement Property”). In this type of exchange, the disposition of the Relinquished Property and acquisition of the Replacement Property must be mutually dependent parts of an integrated transaction constituting an exchange of property. In other words, the properties must be held for investment or use in a trade or business (which has been interpreted by the IRS and courts alike), the Replacement Property must be taken in the same name as the Relinquished Property was titled in and the Replacement Property must be of a “Like Kind,” also determined by the IRS and Congress.
Often, and usually advisable, someone engaging in a deferred 1031 exchange will hire an exchange facilitator, often also acting as Qualified Intermediary, who is experienced in the 1031 procedures and can facilitate the exchange pursuant to the rules provided in the Income Tax Regulations. It is very important to have an intermediary, since according to the tax code and regulations the taxpayer can have no rights to the funds being held in the interim until the exchange is complete. The exchange facilitator often acts as the QI, holding the funds for your benefit until the exchange is complete, so as not to inadvertently invalidate the exchange. While hiring an exchange facilitator is an added expense, if you do not conduct an exchange properly, you will lose the tax benefit of doing so.
The two time frames which you must pay close attention to in a deferred 1031 exchange are the 45-Day Clock and 180-Day Clock. In a deferred exchange, you have 45 days from the date you sell the Relinquished Property to identify a potential Replacement Property or properties. The identification must be in writing, signed by you (the taxpayer), and delivered to the seller of the Replacement Property or the QI. Second, the Replacement Property must be purchased and the exchange completed no later than 180 days after the sale of the Relinquished Property or the due date, with extensions, of the income tax return for the tax year in which the Relinquished Property was sold, whichever is earlier.
The last exchange I will discuss in this article, and perhaps the most technically challenging 1031 exchange, is the reverse 1031 exchange. Yes, that sounds like some sort of figure skating move, and well, it may be just as complicated if you do not have an experienced attorney, accountant and QI guiding you through the process. In this scenario, you first acquire the Acquisition Property, property B, through an exchange accommodation titleholder (“EAT” also often the QI). Then, within the 180-Day Clock, you must sell your Relinquished Property, property A. Next, you take title from the QI of the Acquisition Property, which has been “parked” by the QI, and the exchange is complete. Simple, right? Not so fast – there are many intricacies that go into this process and hence the need to consult with attorneys experience in the field and Certified Exchange Specialists such as Mr. Brecher. For more information please feel free to contact the Suffolk County Women’s Bar Association or Mr. Brecher directly at 1-917-455-1551.