Essential Knowledge for Tax Deferred Exchange Jason Pastucha, REALTOR 2008

Tax Deferred Gains in Exchange The payment of capital gains and recapture of depreciation taxes are indefinitely deferred in a qualifying 1031 exchange. The payment of capital gains and recapture of depreciation taxes are indefinitely deferred in a qualifying 1031 exchange. BASIS Purchase Price Sales Price CAPITAL GAIN (15% TAX) RECAPTURE (25% TAX) DEPRECIATION ADJUSTED BASIS TIME GAIN

IRC Section 1031 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 either for productive use in a trade or business or for investment. 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 either for productive use in a trade or business or for investment.

Exchange Requirements 1. The properties exchanged must be for business use or held for investment. 1. The properties exchanged must be for business use or held for investment. 2. The taxpayer must not get actual or constructive receipt of proceeds. 2. The taxpayer must not get actual or constructive receipt of proceeds. 3. Use of a Qualified Intermediary qualifies the exchange for Safe Harbor protection. 3. Use of a Qualified Intermediary qualifies the exchange for Safe Harbor protection Day Identification and 180 Day exchange closing time requirements Day Identification and 180 Day exchange closing time requirements. 5. Total deferment of taxable gain in an exchange requires a trade “up or equal” in both Equity and Fair Market Value. 5. Total deferment of taxable gain in an exchange requires a trade “up or equal” in both Equity and Fair Market Value.

Exchange Parties QI is assigned Exchanger’s contract rights QI is assigned Exchanger’s contract rights Qualified Intermediary Exchanger Buyer Seller Sale Proceeds Purchase Funds Contract Rights Title In Title Out

Qualified Intermediary Safe Harbor QI holds funds from sale for purchase of replacement property. QI holds funds from sale for purchase of replacement property. QI prevents constructive and actual receipt of sale proceeds by Exchanger. QI prevents constructive and actual receipt of sale proceeds by Exchanger. Exchange Agreement establishes the legal relationship between QI and Exchanger. Exchange Agreement establishes the legal relationship between QI and Exchanger. *Exchanger’s contract rights assigned to QI

Exchange Time Requirements 45 Day Identification Period 180 Day Exchange Period The 45 day identification and the 180 day acquisition timelines both begin on the closing of the sale of relinquished property Non-simultaneous=Relinquish and Replacement

“BUY to HOLD” = Exchange Intent at time of exchange controls. Intent at time of exchange controls. Investors buy with intent to hold property for income and appreciation benefits. Investors buy with intent to hold property for income and appreciation benefits. “Buy to Sell” Dealer transactions do not qualify for 1031 Tax-Deferral. “Buy to Sell” Dealer transactions do not qualify for 1031 Tax-Deferral. Pattern of regular, frequent, and continuous sales indicate “Dealer” status. Pattern of regular, frequent, and continuous sales indicate “Dealer” status. Properties held for less than two years appear more like “Dealer” property. Properties held for less than two years appear more like “Dealer” property.

Tax Deferred in 1031 Exchange BASIS $30,000 $50,000 Purchase Price $150,000 Sales Price CAPITAL GAIN (15% TAX) RECAPTURE (25% TAX) DEPRECIATION ADJUSTED BASIS $100,000 $70,000 $80,000 Gains are Tax Deferred, $30k Recapture + $50K CapGains *Deferring payment of $15,000 in taxes Time

Deferment of Taxable Gain Rule – To totally defer taxable gain in an exchange, taxpayers must trade up or equal in both Equity and Fair Market Value. Rule – To totally defer taxable gain in an exchange, taxpayers must trade up or equal in both Equity and Fair Market Value. Alternative – Mortgage relief or cash received is taxed to the extent of the gain realized (cash added offsets mortgage relief). Alternative – Mortgage relief or cash received is taxed to the extent of the gain realized (cash added offsets mortgage relief).