1031 Exchange for Doctors! Are you a doctor who wants to know the 1031 Exchange? No need for a real estate expert to explain this deal. Today is your lucky day since you’ll learn this tax-deferring trick for FREE!
Here are the things that you will learn after reading:
- What is a 1031 Exchange?
- How Doctors and Physicians can Benefit from 1031 Exchange.
- What are the Rules of a 1031 Exchange 2019?
- How Long do you Have to buy a Property With a 1031 Exchange?
- How Many Properties can be Identified in a 1031 Exchange?
- 1031 Exchange Steps
Let’s start by introducing the 1031 exchange for dummies!
What is a 1031 Exchange
The 1031 Exchange also called as Starker Exchange or Like-Kind Exchange is a procedure that allows an investor to sell or buy a ‘like- kind’ property without requiring immediate payment for the capital gains taxes.
However, prior to deferring the capital tax, the investor must first establish pieces of evidence proving that the capital used for the purchased of a new property is derived from the proceeds of previously owned ‘like- kind’ property.
This tax- deferring strategy is operating under the mandate of section 1031 of the IRS code; hence, the term ‘1031’ Exchange.
5 Advantages of 1031 Exchange (Finally Revealed)
1. Tax Scape:
This procedure is a ‘smooth’ way of skipping real property obligations, including capital gain, ordinary income, and depreciation taxes.
2. Augments Cash Flow for Reinvestment:
Deferring capital gain taxes would mean adding capital for purchasing a new ‘like- kind’ property. The savings would capacitate the investor to procure several properties with the hope of yielding positive Return of Investment (ROI).
3. Management Relief:
To keep yourself from getting burn out from high maintenance cost, 1031 would be your best ally. You can have a deal with another investor and exchange respective properties (without upfront payment of capital gain taxes) provided that the two properties operate under the same umbrella or industry.
4. Wealth Buildup and Asset Accumulation:
Real estate experts suggest that employing a 1031 Exchange strategy in running a business would actually mean yielding a high profit in the long run. Based on the reports of Breakwater Equity Partners, real estate investors who perform 1031 exchanges for decades would significantly increase their net worth and would pass the same financial stability to their successors.
5. Easy Changing of Property:
Under the provisions of the 1031 exchange, you are allowed to hover from one type of real estate property to another. Like for example if you want to swap your idle land lot to residential space.
How Doctors and Physicians can Benefits from 1031 Exchange
Medical practitioners would cut a large margin of their capital gain taxes once they master the 1031 Exchange rule.
For example, a team of US doctors built a hospital in 1993 amounting to $400,000 with a current fair assessment value of $1.2 million and under the sailing of $100,000 income tax obligations and then would like to expand and exchange it with a new and bigger facility.
If you target a $1.2 million selling price (of the old hospital building) you would get a $1.1 million sale’s profit ($1.2 million- $100,000).
If you carry out this deal, this would inflict a 15% federal tax rate. To avoid this huge tax liability, the management would rather prefer to engage in an exchange of property under the scope of the A71031 Exchange. With this scheme, the doctors would not only procure a larger facility but enjoy a $165,000 tax savings as well.
Medical practitioners can also utilize the 1031 Exchange rule to reduce the real estate selling price that would only benefit the clinic’s management. If they reduce the real estate liabilities, they can now top up the savings to their professional fee without compromising their original professional charge.
What are the Rules of a 1031 Exchange 2019
To qualify for 1031 Exchange, you need to consider the following rules:
1. Business or Investment Property Only.
You cannot avail the 1031 Exchange rule if you are dealing with personal property. Only swapping of business or investment properties are allowed under the provisions of section 1031 of the Internal Revenue Code.
Consider the following examples:
a. If you get married and decided to move residence to the place of your spouse, you are not allowed to swap your current primary residence for a rest house.
b. If you moved from Georgia to California, you cannot exchange your primary residence in Georgia for another primary residence in California.
(Check the 1031 exchange California to learn the scope of the exchange in different states)
c. If you own a rental townhouse property in Chicago, you can swap your property for another commercial rental house located in Texas.
2. Equal or Greater Value:
To completely defer from any real property taxes upon selling a property, make sure that the assessed equity and net market value of the newly purchased property is equal or greater than the sold property. If you cannot meet this requirement, you cannot qualify for a 100% tax deferment.
3. Like-Kind Property
The primary requisite to avail the 1031 Exchange is that the property being sold must be the same in form or in nature with the newly- acquired property. This is called as ‘like- kind’ properties. Only the ‘character’ and the ‘nature’ of the property are considered in the 1031 procedure, hence, you are allowed to exchange properties with a different grade or quality.
Here are a few examples:
a. It is allowed to swap a 3-room rental apartment property for a 3-story commercial building.
b. If you own a duplex, you can swap it for an apartment house.
c. You can also exchange your vacation house property for a commercial restaurant space.
4. Must Reflect the Same Tax Owner:
The title of the property and the tax return must contain the same name to qualify for 1031 exchange. However, there’s an exception to this rule in case you are dealing with a sole member limited liability corporation which is allowed to reflect the name of the other members.
Based on the 1031 exchange 2018 records, this rule was given much emphasis by the investors. Hence, you must not disregard the significance of checking the veracity of the papers of the other transacting party.
5. 45 Day Rule:
It is mandated that within 45 days, the property owner must identify up to three like-kind properties potential for exchange. This rule is quite challenging to comply since all the deals must conform to the financial perspective. Most of the investors tend to overprice their property quote especially in times of low interest rates.
6. No ‘Boot’ Allowed:
To enjoy a complete tax-free exchange, you must not receive ‘boot’ in the course of the transaction. ‘Boot’ simply refers to the tax fine for not complying with the requisites of the section 1031 (tax-deferred exchange).
7. 180-Day Purchase Leeway:
After trading a property and the due of the income tax return, it is required that within 180 days, the replacement property must be received by the new owner.
Want to know which of these rules is best to follow? Read here for suggestions. Also, do not forget to check the 1031 exchange rules 2018 reviews for some references.
How Long do you Have to buy a Property With a 1031 Exchange?
After the close of the relinquished property, the investor is only given 45 days maximum to suggest prospect replacement properties, and another 135 days to complete the acquisition of the replacement property.
How many Properties can be Identified in a 1031 Exchange
A maximum of three properties is allowed in 1031 Exchange as per directed by the 3 Property Rule. The taxpayer may suggest three replacement potentials and is also allowed to procure the three nominated properties.
1031 Exchange Transaction Glitches That You Must Avoid
Like any other transactions, the 1031 Exchange also has some glitches. Whether you are looking at the provisions of 1031 exchange rules 2019, some issues are still inevitable.
Check them out now.
1. Early Fund Returns
There could be a time that a taxpayer suddenly decides to halt the transaction. When this occurs, the taxpayer is obliged to inform the exchange company about the matter and that he or she fully understands the responsibility of paying gain taxes.
You have to remember that exchange facilitators are only mandated to disburse funds at a certain point of the transaction and with a valid reason, and the sudden termination of a deal is not part of that disbursement coverage.
In cases like this, the client doesn’t need to worry since he or she is obliged only to pay applicable and due taxes.
The problem occurs when the facilitator tends to deviate from the exchange rules that may put the previous and succeeding exchange deals in jeopardy.
2. Not Knowing the Person Behind:
Make sure to confirm the identity of the person behind the 1031 exchange transaction.
You must validate the exchange firm if they, indeed, did not receive any designation request for a particular property that is subject for swapping.
If the taxpayer fails to do this, he or she is allowed to receive funds only after the process of identification to be conducted by the exchange company.
3. Payout Pitfall:
It is common for the taxpayer to provide a huge amount of money during the course of the exchange transaction. While there’s no wrong in showing financial stability, be aware also that prior to the purchase of the replaced property, any unsanctioned released of money is under the taxpayer’s responsibility. Under the rules, the taxpayer is not entitled to receive any form of reimbursement at the onset of the transaction.
1031 Exchange Steps
There are certain steps to ensure you are doing 1031 exchange the right way. Read the steps below:
(Before Closing the Renounced Property)
1. Relinquished Property Addendum:
Make sure that you add the Relinquished Property Addendum (RPA) to the sale of the property contract. While this addendum form is not strictly required, this would somehow harness the intent to enter an exchange agreement between two parties.
Providing such details would also imply confidence in providing complete permission for the intermediary to do its tasks to prepare the necessary documents, and also divulge that there’s no outstanding liability for the buyer.
After the exchanger approved the contract on the renounced property, a copy of the contract must be provided to the preferred intermediary. Indicate also the name and phone number of the settlement attorney, including the escrow or company agent who will lead the settlement process.
Then, the Exchange and Escrow Account Agreement of Contract, Notification of Assignment, and instruction to the settlement body will be prepared by the qualified intermediary.
(After Closing the Renounced Real Property)
2. Preparation of Funds:
The settlement attorney then prepares the funds to the qualified escrow as sanctioned by the qualified intermediary. The copy of the exchange fee voucher and settlement statement will be released to all parties.
After transferring the relinquished property, the exchanger is only given 45 days to nominate a replacement property.
This process has three provisions: the replacement must be received before the end of the 45- day period, it is allowed to nominate more than three prospects provided that they all constitute to a fair value, and to identify more than three replacement properties with a cumulative fair market value that does not go beyond 200% of the relinquished property.
4. Exchange Period:
After identifying the replacement property, you are given a 180- day exchange period to transfer the replacement property to your ownership.
5. Before Transferring the Replacement:
When the contract for the desired replacement is made, another copy of RPA must be provided to affirm that, indeed, the replacement property is of the same kind and is eligible for a like-kind exchange.
6. After Settlement:
Once the intermediary receives the final settlement statement of the replacement property, the intermediary will then pay any earned interest and return the excess escrow fund.
The final step is reporting the complete transfer of property as required by the annual tax return report. You may use Form 8824 (IRS) in your report.
With these benefits, are you ready now to engage in 1031 Exchange?
If you are a doctor, the more that you must master this tax- deferring trick.
So, when do you want to start the exchange?
Let us know by sharing your comments.