In its simplest terms, Qualified Intermediaries (QI), facilitating Section 1031 Exchanges, act as a third party in the sale of Relinquished Property (old property). The QI’s job is twofold: a) memorialize and document the intent of the taxpayer and b) function as escrow agent for the net proceeds from sale. Section 1031 is a tax mechanism to substitute existing property for new property without paying capital gains tax or recapture of depreciation. The QI works in concert, not as a substitution, with the taxpayer’s other professionals (real estate agent, attorney and accountant) to minimize any exposure to capital gains tax.
Encouraging the taxpayer to consult with their tax professional early in the process will produce the best results. Too often, the taxpayer waits until the funds are in hand to make a decision regarding utilizing Section 1031. The receipt of funds at closing of the Relinquished Property triggers tax. It can be avoided if action is taken before the sale to engage a QI. Taxpayers who wait to have the discussion with their professionals after the funds are in hand will find out how difficult it is to un-wind a sale, if at all, and the pain of writing a check to the tax man. Plan ahead for the best results.
It is important to note that the entire value of the Relinquished Property is exchanged for the new or Replacement Property. Taxpayers are often mistaken that they only have to roll the profit into new property to avoid tax. Exchanges must be conducted within strict time frames and no extensions are available unless a natural disaster is declared. The entire exchange must be concluded in 180 days or the due date of the taxpayer’s tax return, whichever occurs first. The exchangor has a mere 45 days to develop a list of possible Replacement Property options. After day 45, no substitutions or changes can be made to the Identification List. Specific guidelines are provided in a choice of three Identification Rules ranging from three properties of any value to unlimited number of properties with the value capped at 200% of the old property or any number or value as long as 95% of the identified property is eventually acquired.
Exchanges provide tremendous advantages, they are rule driven so a QI can help keep your transaction in line. The first rule is get good advice before you jump!
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