Section 1031 Exchange - The Basics

THE BASICS – SECTION 1031 TAX-DEFERRED EXCHANGES GROW YOUR INVESTMENT,

NOT YOUR TAX BILL

IOWA EQUITY EXCHANGE4800 Mills Civic Parkway, Suite 205

West Des Moines IA 50265

800-805-1031 toll free

515-224-5259 office

[email protected]

WWW.IOWAEQUITYEXCHANGE.COM

mailto:[email protected]

http://www.iowaequityexchange.com/

THE BASIC CONCEPT

• Section 1031 of the Internal Revenue Code allows a property owner to sell his property and reinvest the proceeds of the sale in “like-kind” property without recognition of gain.

• Because the property owner has no tax obligation, he is able to put more money to work in the new property, potentially increasing his equity more quickly.

INTEGRITY. PRECISION. SECURITY.

BACKGROUND—IRC SECTION 1031

• 16th Amendment was ratified in 1913.• Tax-deferred exchanges started in 1921.• (IRC) §1031(a)(1) states that “No gain or

loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held for productive use in a trade or business or for investment.”

• Similar to IRA rollover—the investor is changing the form of the investment, not the investment itself; therefore, no gain is recognized.


A QUICK INTRODUCTION TO §1031

There are five basic requirements to qualify for tax-deferred treatment under the Internal Revenue Code.


1. THE PROPERTIES MUST QUALIFY.

• In IRS terms, they must be “like-kind.”

• Ask yourself this: Did I hold property being sold as an investment or use it in my business?

• E.g., raw land can be exchanged for an apartment complex; a rental house can be exchanged for an office building.

• Can I substantiate that property was held for investment or used in a business?

• I.e., no “flip” property—such property is considered inventory, or dealer property.


2. YOUR INTENT TO EXCHANGE MUST BE ESTABLISHED.

• IRS offers you a Safe Harbor, but you must establish your intention to exchange.

• Must be done prior to closing.

• Must be done in writing with your Qualified Intermediary (company providing exchange services).


3. YOU MUST AVOID “ACTUAL OR CONSTRUCTIVE RECEIPT” OF THE FUNDS. • Another of the Safe Harbor provisions.

• Neither you, nor your agent, may take possession of the proceeds of the sale.

• Neither you, nor your agent, may have control of the funds during the exchange period.

• Using a Qualified Intermediary allows you to avoid violating this clause.


4. YOU MUST PROPERLY IDENTIFY THE PROPERTY TO BE PURCHASED. • After closing of the “relinquished property,”

you have 45 days to identify potential “replacement properties.”

• No extensions are allowed. Forty-five calendar days—period.

• You must choose one of three rules to follow when identifying property; most choose the “Three-Property Rule.”


5. YOU MUST ACQUIRE THE NEW PROPERTY.

• Starting with the date of closing of the relinquished property, you have 180 days to acquire (close on) your replacement property.

• Again, no extensions are allowed.

• At closing, funds in your exchange account are paid directly to the closing agent to purchase the new property.


SO, WHY

EXCHANGE?


AN EXAMPLE

• Property was purchased in 1984 for $78,500.

• Property has been fully depreciated. (Original purchase price was allocated $70,000 to improvements, $8,500 to land.)

• Property was sold in 2007 for $155,000.


NET PROCEEDS STATEMENT

Sale PriceExpenses of Sale (10%)Tax ProrationProrate RentsTransfer Security Deposits

$155,000- 15,500- 3,500- 2,000- 2,000_________

Net Proceeds $ 132,000

WHAT ARE THE TAX RAMIFICATIONS IF THIS PROPERTY WERE SOLD WITHOUT THE BENEFIT OF §1031?


$ 155,000 Sale price- 8,500 Basis- 15,500 Costs of sale$ 131,000 Capital gain- 70,000 Depreciation taken

$ 78,500 Purchase price- 8,500 Basis$ 70,000 Depreciation taken

$ 61,000 Taxable gainX 15% Capital gain rate$ 9,150 Capital gain tax

$ 70,000 Depreciation takenX 25% Recapture$ 17,500 Recaptured depr.

$ 9,150 Capital gain tax+ 17,500 Recaptured depreciation$ 26,650 Federal tax obligation


IN IOWA, THE STATE TAXES CAPITAL GAINS AT 8.98%$131,000 Capital gainX 8.98% State capital gain rate$ 11,764 State capital gain tax

$ 26,650 Federal tax obligation (cap gain + depr recap)$ 11,764 State capital gain tax$ 38,414 TOTAL TAX OBLIGATIONS

State taxes have not yet been considered…

THE NET RESULT:$132,000 Net proceeds from sale- 38,414 Deduct total tax obligations$ 93,586 Available for reinvestment after paying TAXES!!!

29.1% of proceeds would go to taxes if not exchanged…


THE WEALTH-BUILDING POWER OF THE 1031 EXCHANGE

A QUIZ (multiple choice):“In real estate, you make your money when you ________.” (Hint:

it’s “B.”)

A. Sell.

B. Buy.

C. Collect that sweet rent check every month.

D. Rake in the cash from eBay when you sell all of the stuff that your tenant left behind when he abandoned your property.



Scenario #1 – Buy $150,000 property for $135,000; 100% mortgage at 7%, 30 years.

After 10 years, at 4% appreciation, your property is worth $212,000. You owe $116,000. Your gross equity is $96,000.



Scenario #2 – Buy $150,000 property for $135,000; 100% mortgage at 7%, 30 years.

After 5 years, at 4% appreciation, your property is worth $178,000. You owe $127,000. Your gross equity is $51,000.

You exchange out of that property into property worth $370,000 that you buy for $333,000, using $33,300 of your gross equity as a down payment. (Remainder to sale and purchase expenses.)

After 5 more years, at 4% appreciation, your property is worth $439,000. You owe $282,000. Your gross equity is $157,000.



My version:

You make your money when you buy and exchange, because exchanging allows you to continue buying tax-free.

Rhetorical question—if we make our money when we buy… should we buy more often?


ANYTIME THE SALE OF PROPERTY AND REINVESTMENT OF THE PROCEEDS IS CONSIDERED, THINK ABOUT AN EXCHANGE.Consultations are free!

So what is the procedure for beginning an exchange?• List (or sell) an investment property (or a property

that someone has used in the pursuit of a business).• Contact Iowa Equity Exchange either before or after

signing the Purchase Agreement, but CONTACT MUST BE MADE PRIOR TO THE CLOSING OF THE SALE.

• We will take care of all of the documentation, timing considerations, notifications to your client, their advisors (and you, if you’d like), and oversee the entire process to ensure compliance with IRC regulations for a successful and proper Section 1031 exchange.


WHAT DISTINGUISHES IOWA EQUITY EXCHANGE FROM OTHER QUALIFIED INTERMEDIARY COMPANIES?• Our fees—a standard exchange is only $695. • We speak your language. Because we are not attorneys or

accountants, we will not confuse you with meaningless mumbo-jumbo.

• We are members of the Federation of Exchange Accommodators.

• Funds held for the client during an exchange earn outstanding interest rates; often enough to offset our fee entirely.

• Our clients’ funds are held in fully liquid, strictly segregated money market accounts. Funds are never commingled. Accounts are viewable online 24/7 for your peace of mind.

• Security is available for every dollar of every exchange account.


QUESTIONS?

It is extremely common to have lots of questions. Please get in touch with us and we will be happy to address anything that is on

your mind. Contact info is on next slide.


THANK YOU!

4800 Mills Civic Parkway, Suite 205West Des Moines IA 50265800-805-1031 toll free

515-224-5259 [email protected]

WWW.IOWAEQUITYEXCHANGE.COM

mailto:[email protected]

http://www.iowaequityexchange.com/

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Section 1031 Exchange - The Basics