PAY NO CAPITAL GAINS TAX WHEN DISPOSING OF INVESTMENT REAL ESTATE

Thinking of selling a piece of Real Estate that is held as either business or investment property? Do you know what your tax liability would be if you sold it? Exchangeit instead and “PAY NO CAPITAL GAINS TAX”. Sounds to good to be true? Its not! Real Estate Exchanges, Like-Kind Exchanges and Deferred Exchanges (all being one in the same), are the “Best Kept Secret In Real Estate”. Although Section "1031", of the Internal Revenue Code has been available since 1921, with the recent Treasury Regulations, we are finding that these Reg.'s are having a profound effect on the way Real Estate is changing hands in the United States today. Tax experts are calling these Regulations the most significant guidelines for the Real Estate Investor in years. 

NEW REGULATIONS REMOVE FEAR OF IRS CHALLENGE 

These Regulations, are so favorable that even the most conservative investor is taking advantage of Section "1031" of the Internal Revenue Code, because they provide clear guidelines for Taxpayers to follow in structuring an Exchange. In the past, many owners of business and investment property feared that with the absence of any clear IRS procedural rules, the IRS would challenge their Exchangeand would impose costly penalties on them. That concern has been effectively removed by these Regulations. 

The Regulations pertain to what are called "Deferred" Exchanges. Under Section "1031" of the Internal Revenue Code, "No gain or loss will be recognized for tax purposes if property held for trade, business or investment purposes is Exchanged solely for a property of a "Like-Kind" which will be held for trade, business or investment purposes." 

The words "Like-Kind" have a very broad interpretation under this section of the Internal Revenue Code. For example, it can include a rental condo in Exchangefor a warehouse, an office building for a parcel of land, or an apartment building in Buffalo, New York for a shopping center in Tampa, Florida. 

SOME ADVANTAGES OF EXCHANGING VS. SELLING REAL ESTATE 

The advantage that most taxpayers (sellers) are attracted to is that an Exchangecan defer federal and in most cases state income taxes indefinitely which would be due on the capital gain (profit) at the time of disposing. This means you can receive an interest free loan from Uncle Sam for the amount of the tax liability if you properly structure the transaction as an Exchangerather than a Sale. 

Other possible advantages of an Exchangeinclude the following: -Exchangefrom non-productive land into income producing property which can 
 create (Cash Flow):. -Exchangefrom a large property into many small properties to diversify one's  portfolio: -Exchangefrom many smaller properties into one large property to consolidate  ownership and management: -Being able to possibly double or triple one's real estate portfolio with no 
 additional capital investment by just using their total current equity in their  property: -Being able to increase one's tax shelter position by trading up with the use of 
 leverage: -Being able to disinherit Uncle Sam of your deferred tax liabilities because your heirs would receive a Stepped-Up-Basis when you bid this world good-bye, 
 (referring to income tax not estate tax). Today, most people realize that the only time you should sell real estate instead of exchanging it is when you want to get out of the business of Real Estate altogether. 

OUR GOVERNMENT ENCOURAGES REAL ESTATE ExchangeS 

Both the 1984 and the 1986 Tax Reform Acts have encouraged the use of Exchanging. The '84 Act allowed for what is called a "Delayed Exchange." In addition, due to the preferential capital gains tax treatment being eliminated in the '86 Act, interest in the use of Exchanges has been heightened. Although January 1, 1991 brought the return of the so-called "favorable" Capital Gains Tax treatment most people have realized its not really that favorable after all and they are still turning to Exchanging.

EXAMPLE: The tax ramifications of Selling vs. Exchanging with the favorable capital gains tax treatment. You are thinking of selling a piece of land which you owned for the last ten years and your accountant tells you that you will have a capital gain (profit) of $100,000. If you treat the transaction as a Sale on a cash out basis, the combined tax liability for federal and state, if filing in New York State, could be a tax rate of 32%, for a $32,000.00 tax liability. That 32% of the gain would go to Uncle Sam in the form of income tax. If the transaction was treated as an Exchange, both federal and state income tax is deferred indefinitely.

HIGHLIGHTS OF NEW MAJOR PROVISIONS 

The two major qualifying requirements for Exchanges are that the property the Taxpayer is coming out of cannot be used as their "Principal Residence" or vacation home and the Taxpayer must acquire other "Like-Kind" property with the proceeds instead of receiving cash at the closing.

DEFERRED ExchangeS 

The Regulations define a "Deferred Exchange" as an Exchangein which, pursuant to an ExchangeAgreement, the taxpayer transfers property held for productive use in trade or business or for investment (the Relinquished Property) and subsequently receives property to be held either for productive use in trade or business or for investment (Replacement Property). A Deferred Exchangeis when the titles to the Relinquished and Replacement Property are not transferred simultaneous. A Deferred Exchangewill be entitled to the same benefits under Section "1031" as a simultaneous Exchange, so long as two additional requirements are met: [1] The Replacement Property must be identified within 45 days after the date of the original transfer of the Relinquished Property (“Identification Period”), and ‚[2] The Replacement Property must be received within 180 days of the transfer of the Relinquished Property or before the due date (including extensions) of the Taxpayer's return, whichever occurs sooner (“ExchangePeriod”), The Regulations clarify that neither the Identification Period, nor the ExchangePeriod is extended to the following business day if it ends on a Saturday, Sunday or Holiday. If the Taxpayer transfers more than one Relinquished Property as part of the Exchange, the Identification Period commences on the date of the first transfer. Identification of Replacement Property

Replacement Property, must be identified either in written document signed by the Taxpayer and hand-delivered, mailed, telecopied, or otherwise sent before the end of the Identification Period to "a person involved in the Exchange", or in the ExchangeAgreement signed between the parties. The Replacement Property must be unambiguously described by a legal description, street address or assessor's parcel number. Any Replacement Property received by the Taxpayer before the end of the Identification Period will be deemed to have been timely identified. 

The maximum number of Replacement Properties the Taxpayer may identify (regardless of the number of Relinquished Properties in the same Deferred Exchange), is either: [a] Three properties without regard to the fair market values of the properties (the 3-property rule)‚or [b] Any number of Replacement Properties as long as their aggregate fair market value at the end of the Identification Period does not exceed two hundred percent of the aggregate fair market value of all Relinquished Properties (the 200% rule). If more properties than are allowed under these two rules are identified, the entire Exchangewill be disallowed unless the Taxpayer acquires at least 95% (95-percent rule), of the aggregate fair market value of the identified Replacement Properties. The Regulations provide that "incidental" personal property (furniture or equipment) need not be identified separately, nor counted separately. Personal property is treated as "incidental" if its value does not exceed 15% of the value of the real property it accompanies. 

Actual or Constructive Receipt 

Gain is recognized to the extent the Taxpayer is "in actual or constructive receipt" of "money or other non-like-kind property". However, if the Taxpayer's control over the receipt of monies is subject to "substantial limitations or restrictions", then the Taxpayer will not be considered to be in constructive receipt of such money. 
Safe Harbors The Regulations establish procedures to follow in structuring an Exchangewhich will allow the Taxpayer to avoid actual or constructive receipt of the cash (safe harbors). There are four approved safe harbors: 1.Security or Guaranty Arrangements; 2.Qualified Escrow Accounts and Qualified Trusts; 3.Qualified Intermediaries; 4.Interest or Growth Factors. 

Qualified Intermediaries 

The use of Qualified Intermediaries is probably the most important safe harbor in the Regulations. A Qualified Intermediary cannot be the Taxpayer or a "disqualified person." A "disqualified person" is some one who is considered the agent of the Taxpayer at the time of the transaction. If a person has acted as the taxpayer's employee, attorney, accountant, investment banker or broker, or real estate agent or broker within a 2 year period prior to the transfer of the first Relinquished property, they are treated as a disqualified person/agent of the Taxpayer and therefore are not allowed to act as a Qualified Intermediary in the Exchange. 
When picking a Qualified Intermediary, one should use a Professional Qualified Intermediary who has the proper training and experience in facilitating Deferred Exchanges. 

The Professional Qualified Intermediary should have special training in negotiation, contract law, taxation, investment analysis, escrow procedures and real estate practices. Choosing a Professional Qualified Intermediary could be the most important step toward developing a defensible Deferred Exchange. 
The Regulations permit "direct deeding" of titles when the transaction is structured to meet the Qualified Intermediary safe harbor criteria. They also permit the Qualified Intermediary to acquire the Relinquished Property and the Replacement Property by assignment of their respective sale and purchase contract rights, from the Taxpayer to the Qualified Intermediary. This enables the Taxpayer to restructure a sale transaction to an Exchangeformat just prior to closing. In addition, the Regulations allow the Interest Income/Growth Factor resulting from the interest accrued by the net equity proceeds in an escrow account or trust to be given to the Taxpayer or used to acquire The Replacement Property. In either case, the Interest or Growth Factor would be taxed as ordinary income. 

People who have been on the sidelines because they feared the risk of the IRS disallowing their Exchange, can now safely put their property on the market and Exchange. With the new Regulations providing clearly defined guidance in structuring Exchangetransactions, no one should sell their property rather than Exchangeit unless they want to get out of Real Estate or just feel like giving Uncle Sam a large percentage of their profits.