Nuances of 1031 exchanges

The tax consequences of trading spaces are fairly painless if you participate in an Internal Revenue Code Section 1031 tax deferred exchange.

Such exchanges allow seller to defer taxable gain on investment properties. The key to this concept is that taxes are deferred which means, of course, that at some point, they must be paid.

While specific rules are but a quick Google or Yahoo search away, here are critical reminders and suggestions which aren't part of any published guidelines:

1. Your purchase agreement is one of the first places an exchange can get into trouble. It's fairly common to receive offers without the required language. In order to comply with IRS requirements, specific language indicating both parties agree to participate must be included in the purchase agreement or the exchange could be disqualified. This could be a very expensive omission if the exchange is later ruled invalid.
2. Remember, an exchange must be like-kind for like-kind which simply stated means real estate for real estate; land for house, house for condo, etc, etc.
3. Another caution which thwarts many local buyers and sellers involves foreigners. The IRS now requires all foreigners involved in real property transactions to have a Tax ID number. Because there are strict time limits (45 days to designate and 180 days to close) related to the exchange, a foreigner involved in a 1031 tax deferred exchange could cause the exchange to exceed the allowable timelines. It's best to apply for a tax ID number early on.
4. Because of the number of title and survey problems in Hawaii, delays in resolving these could extend closing beyond the allowable time. Such delays could result in a failed exchange.
5. Remember, the key to every exchange is the concept of "control of funds." The party relinquishing the funds (the seller who then becomes the buyer) is not allowed to touch either proceeds of the sale (the first leg) or funds being held to complete the purchase (the second leg).
6. An Exchange Accommodator must be used. Exchange accommodators are not regulated in Hawaii so be careful about whom you choose as the third party intermediary.
7. Even though taxes are deferred, it is widely held that an investment property can be converted to personal use after a period of investment use. Investment use for one to two years is probably fine. Anything less could disqualify the exchange resulting in tax consequences of 20% or more (in Hawaii).
8. Most exchanges are fairly straight forward but it's always advisable to consult our financial advisor as well as an attorney versed in such exchanges.
9. Remember, builders of spec homes are dealers. Spec homes sales do not qualify for 1031 tax deferred exchanges.

When it comes time for your next exchange remember to use a REALTOR® who understands the basics especially as relates to our Hawaii market!

Denise can be reached at [email protected] /* <![CDATA[ */!function(){try{var t="currentScript"in document?document.currentScript:function(){for(var t=document.getElementsByTagName("script"),e=t.length;e--;)if(t[e].getAttribute("data-cfhash"))return t[e]}();if(t&&t.previousSibling){var e,r,n,i,c=t.previousSibling,a=c.getAttribute("data-cfemail");if(a){for(e="",r=parseInt(a.substr(0,2),16),n=2;a.length-n;n+=2)i=parseInt(a.substr(n,2),16)^r,e+=String.fromCharCode(i);e=document.createTextNode(e),c.parentNode.replaceChild(e,c)}t.parentNode.removeChild(t);}}catch(u){}}()/* ]]> */

Mealoha can be reached at [email protected] /* <![CDATA[ */!function(){try{var t="currentScript"in document?document.currentScript:function(){for(var t=document.getElementsByTagName("script"),e=t.length;e--;)if(t[e].getAttribute("data-cfhash"))return t[e]}();if(t&&t.previousSibling){var e,r,n,i,c=t.previousSibling,a=c.getAttribute("data-cfemail");if(a){for(e="",r=parseInt(a.substr(0,2),16),n=2;a.length-n;n+=2)i=parseInt(a.substr(n,2),16)^r,e+=String.fromCharCode(i);e=document.createTextNode(e),c.parentNode.replaceChild(e,c)}t.parentNode.removeChild(t);}}catch(u){}}()/* ]]> */