1031 MYTHS

Let's Clarify Some Common Misconceptions About 1031 Exchanges

MYTH #1: 

LIKE-KIND MEANS THE SAME TYPE OF PROPERTY, LIKE A RENT HOUSE AND ANOTHER RENT HOUSE!

FACT:

Any real property primarily "held for productive use in a trade or business or for investment" qualifies as "like-kind" under 1031, even different types.

So, for example, an oil refinery and a banana plantation could be "like-kind" if both are held or intended to be held primarily for business or investment.

Similarly, a skyscraper could be "like-kind" to unimproved land.

MYTH #2:

THE EXCHANGE MUST BE BETWEEN ME AND ANOTHER OWNER!

FACT:

The exchange does not need to be between 2-parties.

If YOU give up Property-1 (P-1) in exchange for Property-2 (P-2)

and if BUYER will buy P-1 and SELLER would sell P-2, you will need Another "Party" called a QUALIFIED INTERMEDIARY (a QI) for

a 4-party exchange: YOU, BUYER, SELLER and QI.

YOU exchange P-1 for P-2 with the QI.

QI sells P-1 to your BUYER, who pays QI then with proceeds,

QI buys P-2 from your SELLER so

YOU and QI may complete the exchange.

MYTH #3:

WE MUST EXCHANGE PROPERTIES SIMULTANEOULY!

FACT:

The exchange does not need to be simultaneous.

Use that same 4-party scenario above with a Delayed Exchange:

The Sale from the QI to BUYER could close

and the QI could hold ("park") the proceeds in an

EXCHANGE ACCOUNT until a later date when the

Purchase from your SELLER occurs (as long as you

"Identify" P-2 to the QI within 45-days and Complete

the exchange by 180-days).

MYTH #4:

WE CAN'T TAKE OUT ANY CASH!

FACT: 

Let's say in exchange for your property worth $400,000

you receive both $100,000 in CASH plus "like-kind" property

worth only $300,000, so you received equal value.

The cash is called "boot" and the IRS would recognize the gain on only the $100,000 cash portion of the exchange as "taxable" but not the gain on the $300,000 (like-kind) portion.

So the resultant tax on the "partial 1031 exchange" should be substantially less than the tax for a $400,000 sale.

But with a 1031 you may not touch one penny of the boot

until the exchange is completed.

MYTH #5: 

WE CANT REPLACE PROPERTY HELD FOR LESS THAN A YEAR!

FACT:

The "short-term" gain on property held less than a year

would normally be taxed as ordinary income, a higher

rate than is charged for "long-term" capital gain.

But in a 1031 exchange the gain is not recognized so

No Tax is charged on either long- or short-term gains

or on recaptured depreciation.

MYTH #6: 

MY ATTORNEY COULD ACT AS THE INTERMEDIARY!

FACT: 

Section 1031 requires the intermediary to be "independent" to be "qualified".  Neither you nor any relative may serve as Qualified Intermediary (QI).

Any real estate agent, broker, attorney, accountant, CPA, investment or financial advisor or broker who provided you services in the last 2 years would also be "dis-qualified"

MYTH #7:

MY MONEY WILL BE "HELD UP" FOR SIX MONTHS!

FACT: 

If the QI sells your property then buys its replacement in back-to-back closings, the sale proceeds would never be "held" (QI would have the proceeds applied to the purchase price).  Only if the purchase is "delayed" would the sale proceeds be "parked" until closing.

And if you don't timely "identify" the replacement property in 45 days, funds then held must be returned.

MYTH #8:

1031'S ARE SO COMPLICATED THE FEES WILL BE ENORMOUS!

FACT:

To an experienced IRS Qualified Intermediary such transactions are routine and fees for their 1031 facilitation services may be moderate.

Fees for the services of The 1031 Exchange Center are very modest. 

MYTH #9: 

1031'S ARE ONLY FOR LARGE INVESTORS

FACT: 

A retired lady exchanged her $300,000 rent house for a

$160,000 condo she would rent out as an investment PLUS $140,000 in cash (a partial 1031 with taxable boot).  Had she SOLD the rent house for $300,000 her tax on gains would have been $25,500.

But the taxable boot was only $140,000 out of $300,000 and her tax was only about $11,500 so SHE SAVED $14,000 in taxes and only paid $500 for her accounting and $1,100 for QI services and expenses.

You may ask her if the $14,000 extra she was able to invest made her a "large investor".