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Daily Real Estate News  |  November 5, 2008  |   1031 Exchanges: Tax-Deferred, Not Tax-Free
There are many complex rules governing 1031 exchanges, but one of the most important rules is easy to remember: “If you take the cash, you pay the taxes,” said Craig Brown, a vice president of IPX1031 Exchange, which specializes in exchange transactions.

He instructed a preconference course in Orlando on 1031 Exchanges. The 2008 REALTORSŪ Conference & Expo in Orlando officially kicks off on Friday, Nov. 7 and runs through Monday, Nov. 10.

If a seller exchanges one like-kind investment property for another, and the transaction results in any cash for the seller, that amount is taxable—even if the seller is taking on additional mortgage debt.

“Debt does not offset cash,” said Brown, who is based in Dallas.

Capital Gains Concerns

If your client expects to see cash from a 1031 exchange, it may be better to initiate the transaction in 2008, when the capital gains tax rate is only 15 percent, he said.

“You can’t predict what will happen next year to the capital gain rate, but many of my clients are concerned Congress will increase it next year, and they want to take advantage of the current rate,” Brown said.

If an exchange isn’t completed until 2009, the investor may choose to pay taxes on the gain in either 2008 or 2009 under IRS installment sales rules.

What Qualifies as a 1031?

To qualify for a 1031 exchange, a property must meet four basic rules:
  1. Be held for an investment or used for productive purposes in a business.
  2. Be exchanged with a like-kind property (any other type of real estate).
  3. Investor must identify replacement properties for the one being exchanged within 45 days.
  4. Exchange transaction must be completed within 180 days.

While it’s not possible to exchange a principal residence, a recent court ruling has clarified rules that make it possible to exchange a second home or a vacation home, Brown said.

The property must meet these requirements: The owner has held the property for at least two years; rented the property for at least 14 days per year at fair market value; and used the property personally for no more than 14 days of each year.

Dream House Rules

The same ruling spelled out circumstances under which owners could defer taxes when exchanging any type of investment property for a “dream house,” that they will eventually live in full-time.

First, the investor must rent out the dream home for 14 days a year for at least two years, and use it for no more than 14 days per year. At the end of the two-year span, the home could be converted to a principle residence for the owner’s use.

The two-day session on 1031 exchanges was presented by the REALTORSŪ Land Institute. For more information, visit

—Mariwyn Evans

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