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1031 Investments


Introduction to 1031 Investing

In today's fluid market, there is unusual opportunity for the investor for cash flow, equity build-up and tax advantage.

This section will be devoted to information that an Investor may find helpful.

NOTE:   Please remember that I'm not an Attorney, Tax Advisor, or CPA.  The prudent investor should ALWAYS consult a professional in the field of expertise involved.



Also known as a "Delayed Exchange" or "Starker Exchange", you may find the good old "1031 tax Deferred Exchange" to be a good friend if you are faced with disposal of INCOME PROPERTY or INVESTMENT PROPERTY!  WHY?....'cause these exchanges may allow you to DEFER all that Capitol Gains TAX that you will be on the hook for if you sell that property through normal channels!

View 1031 Basics Infograph Charts

    1.  Allows Investors to DEFER capitol gains tax and use the increased equity to purchase a larger property or properties.
    2.  Investors may be spending more than they like maintaining properties. They can exchange several properties into one!
    3.  Investors may wish to diversify and exchange a property into another city or state.
    4.  An Investor may wish to exchange out of one property that has a lot of equity for several smaller properties.
         If down the road the investor wants to sell off some of the smaller properties, the tax burden would be SIGNIFICANTLY LESS.

    5.  Investors may wish to take advantage of increased growth and appreciation in a specific area.


You have heard that investors are allowed to exchange for "LIKE KIND" property but MOST people do NOT know what this means.

To qualify as "LIKE KIND", any type of real property "HELD FOR INVESTMENT OR PRODUCTIVE USE IN A TRADE OR BUSINESS may be exchanged for ANY OTHER type of real property to be held for investment or held for productive use in a trade or business.

If we study the above paragraph carefully, we can easily see how we ARE allowed to exchange that Rental House, for a speculative land investment, or perhaps exchange that piece of raw land we've had for the last 20 years for a small commercial center, or investment houses or long as the parcels meet the definition of LIKE KIND as given above!


There are several steps that should be followed during the exchange process.

        1.  CONSULT with your tax and financial advisors to determine of a tax deferred exchange is appropriate for your circumstances and compatible with your investment goals.

        2.  LISTING the relinquished property (the one you want to get rid of), with a good Real Estate Agent (Lawrence Yerkes of RE/MAX Preferred) who is familiar with the exchange process.

        3.  OFFER, COUNTER OFFER AND ACCEPTANCE.  Your enter into a contract to sell with a buyer.  The buyer is advised of the exchange.

        4.  OPEN ESCROW AND COORDINATE WITH A FACILITATOR - Earnest money deposits when you sell the old property go to an ESCROW COMPANY.  The EXCHANGE FACILITATOR, a separate company who will do the actual exchange, prepares the exchange agreement and the necessary paperwork coordinates with the Escrow holder.  The sale is closed and the proceeds go to the FACILITATOR.  You are NEVER allowed to have "Constructive USE of the funds derived from a property to be exchanged, except in cases of (taxable BOOT.  This completes phase 1 of a normal tax deferred exchange.

       5.  REPLACEMENT PROPERTY IDENTIFICATION - You have 45 days after you close escrow on your old property (Relinquished Property) in order to IDENTIFY the replacement property.  The identification must be in writing and signed by the exchanger.

        6.  BUYING THE REPLACEMENT PROPERTY - You have 180 days from the date you close on the old property to find and close on the replacement property.  RE/MAX Preferred or a Realtor in your area who is familiar with the exchange process will be happy to help you find just the replacement property that will fit your investment needs.  The purchase contract is substantially the same as a normal contract with a few additional clauses to help insure that your exchange will be valid.

        7.  OPEN ESCROW AND CLOSING THE EXCHANGE -  The Facilitator prepares the Phase 2 Exchange Documents and coordinates with the Replacement property Escrow holder.  At the direction of the Facilitator, the escrow holder deeds the replacement property from the Seller directly to the Exchanger (YOU).  The funds held in escrow by the facilitator are placed in escrow and the replacement property is purchased by the Facilitator from the Seller.  The transaction is closed as Phase 2 of a delayed exchange.

I know this sounds complicated however it really is a normal procedure and is done every day by savvy investors.  I can help you through these steps and we can even recommend a good Facilitator company for you.

Here are a few numbers to help illustrate why you may wish to consider a Tax Deferred Exchange for your income or investment property.


Sales Price: $ 250,000
Loan / Debt: $ 50,000
Proceeds: $ 200,000
Basis: $  $50,000
Estimated Tax Rate 30% State and Federal  
Tax Due: $ 60,000 NO TAX DUE
Cash Available for Reinvestment:  
SALE:   $ 140,000 EXCHANGE:  $ 200,000

As you can see, the tax benefit shown above is HUGE!
Whether you are going from one large property to several smaller properties, or from several small properties to one larger one, or from state to state or city to city, the Section 1031 tax deferred exchange program may be a tool that can substantially assist you in your investment goals.

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1031 IRS Primer


Why exchange real property? To save taxes, yes, but said more succinctly, to build your estate with pre-tax dollars. Using proper exchange techniques results effectively in interest free loans from the government. Other reasons to exchange include:

1031 ExchangesIncreasing depreciable basis by acquiring property encumbered with a larger debt.

Acquiring sheltered income by exchanging for unimproved land for improved property.

Acquiring property without cash, when sales may be impossible.

Consolidating  assets by exchanging many properties for one larger property.

Receiving nontaxable cash by exchanging and refinancing after and independent of the exchange.

Diversifying holdings without tax consequence.

For example, If you acquired an investment property for $50,000 and sold it for $150,000 you would have a $100,000 capital gain (that is not including the gain you would realize because of depreciation taken during the holding period of the property, which lowers the basis and results in higher realized gain). After taxes (30% for the purpose of example, state and federal), you would end up with $70,000 to do what you like with, but let's assume you will use it as a down payment in another property.

Sell        $150,000
Buy         $ 50,000
Gain       $100,000
Tax Brkt      30%
Tax         $ 30,000

Balance to invest: $70,000

Taking that $70,000 and leveraging it 4 to 1 would result in a purchase
of a $280,000 property.  10% annual appreciation in year one would result in an equity increase
of $28,000

Leveraged 4 to 1 results in a purchase of $280,000

10% annual appreciation results in $28,000

If you structured the sale in accordance with section 1031, and did not have to pay the taxes at that time, you could invest the entire $100,000 leveraged 4 to 1 and purchase a $400,000 property.  At 10% appreciation, your increase in equity is $40,000. Multiply this $12,000 equity buildup over a 20 year investment horizon and the result is substantial.

Internal Revenue Code Section 1031

No gain or loss shall be recognized if property held for investment is exchanged solely for a property of like kind to be held either for :

    1. Production of income
    2. Investment
    3. Productive use in trade or business

Property must be of "like kind." This means real property for real property, personal property for personal property. "Like kind" is broadly defined, that is, all real estate qualifies regardless of the "grade or quality." It is the "nature or character" of the property (realty or personalty) and not the name of the improvements (office building, apartment, hotel, etc)  that determines "like kind". This was emphasized in Commissioner of  Internal Revenue v. Chrichton. This case involved the exchange of mineral interests and improved real property.  The mineral interests were held to be like kind property because under state law they were considered real property. In a subsequent revenue ruling, the IRS indicated that water rights also met the like kind test.

Property not qualifying
    1. Stock in trade
    2. Partnership interests
    3. Stocks, bonds, notes
    4. Dealer property

Multiple Properties
    Nothing in Section 1031 prevents a  taxpayer from exchanging out of or into multiple properties.

Tax Consequences
    Exchanges can be fully deferred or partially deferred. Any unlike kind property received in the exchange is considered boot and is recognized (taxable) in the year of the exchange.

Boot is:
    1. Cash or the equivalent of cash
    2. Any unlike kind property
    3. Mortgage relief
    4. Any combination of the above

Cash paid offsets mortgage relief boot. The lower of the gain or the boot is taxable in the year of the exchange.

For a completely tax deferred exchange you must trade up in equity, value, and loan.

Basis of Property Received
    This is referred to as substitute basis and is the Fair Market Value of the property received minus the deferred gain (or plus any deferred loss).

The Process
    As it is in any real estate transaction, you must first identify the objectives of the property owner. What do they want to accomplish? Management problems, lack of control, cash flow, tax concerns; sometimes the owner is not sure of all the circumstances and it may take some time and counseling to make the determination.
    A basic requirement is that all participants receive the same value that they give. The end result should be that there are as many winners as there are participants. Determination of value to the participants in a real estate exchange is not complete without considering the improvement the transaction will make in the owner's life. The analysis must take into consideration the personal circumstances of the participants lives.

Two Party Exchange
    As mentioned before, to structure a completely tax deferred exchange, the investor must acquire property (properties) with equal or greater equity and a larger fair market value than the property transferred (up in equity and value). This assumes that there is gain realized and that the taxpayer pays boot and assumes a larger loan.

Mr. Cash owns an industrial property valued at $372,000 with a loan of $351,000. His basis is $355,000.

He exchanges with Mr. Carry's apartment complex which is valued at $420,000 and has a $381,000 loan against the property. His basis is $392,000.

Basic Structures of a Multiparty Exchange
    The very common three party exchange is comprised of a sale and an exchange, or an exchange and a sale.

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1031 Exchange Basics Charts


Click image for larger view:

(Note: "1031 Exchanges - By the Numbers" links to outside website for full chart)
1031 Exchanges By The Numbers 1031 Exchanges by Cook & Cook


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