Understanding the 1031 Exhange

The following is a transcript from my weekly segment with Michael Collins called "Making Steamboat Home" on Steamboat TV 18. I'm on every week at 8:40.

[BEGIN TRANSCRIPT]

Michael: Are you interested in “Making Steamboat Home?” Well if you are, then you’re in luck, our friend Chad James with Homebuyers Mortgage is back with us again this week to talk about using a tool called a 1031 Exchange to help you make your dreams of living in the Yampa Valley a reality….welcome Chad!

Chad: Thanks, Michael…and Merry Christmas

[Christmas Small Talk]

Michael: Chad, let’s get right into this, what is a 1031 exchange?

Under Internal Revenue Code (IRC) Section 1031, a real property owner can sell certain property and then reallocate the proceeds in ownership of like-kind property and defer the capital gains taxes. To qualify as a like-kind exchange, property exchanges must be done in accordance with the rules set forth in the tax code and in the treasury regulations. The 1031 exchange can offer significant tax advantages to real estate buyers.

Michael: Who should consider a 1031 exchange?

If you have real property that will net you a gain upon sale (generally property that has been substantially depreciated for tax purposes and/or has appreciated in fair market value), then you are exactly the person who should consider a 1031 exchange.

Michael: So, I’m sure that a lot of this has to do with certain tax benefits, right? What types of property can be used for a 1031 exchange?

There are 5 tax classes of property:
1. Property used in taxpayer’s trade or business
2. Property held primarily for sale to customers
3. Property that is used as your principal residence
4. Property held for investment
5. Property used as a vacation home

Section 1031 applies to the first and fourth categories, and sometimes the fifth category. Business use is defined as, "To hold property for productive use in trade or business." Property retired from previous productive use in business can be qualifying property. Investment purpose is defined as real estate, even if unproductive, held by a non-dealer for future use; or the increment in value is held for investment and not primarily for sale. Investment is the passive holding of property, for more than a temporary period, with the expectation that it will appreciate. Property held for sale in the immediate future is not held for investment.

Michael: Chad, why should people consider a 1031 exchange?

· Defer paying capital gains taxes. A properly structured exchange can provide real estate buyers with the opportunity to defer all or most of their capital gains taxes.
· Leverage.
· Upgrade or consolidate property.
· Diversify. Own multiple properties rather than just one.
· Relocation to a new area.
· Differences in regional growth or income potential.
· Change property types among commercial, retail, etc.

Michael: What are the general 1031 exchange rules?

1. The real property you sell and the real property you buy must both be held for productive use in a trade or business or for investment purposes, and must be like-kind.
2. The proceeds from the sale must go through the hands of a qualified intermediary and not through your hands or the hands of one of your agents, or else all the proceeds will become taxable.
3. All the cash proceeds from the original sale must be reallocated to the replacement property—any cash proceeds that you retain will be taxable.
4. The replacement property must be subject to an equal level or greater level of debt than the relinquished property or the buyer will either have to pay taxes on the amount of the decrease or have to put in additional cash funds to offset the lower level of debt in the replacement property.

Michael: Chad, thanks for sitting down and talking with us about this…it sounds like a really great tool to use to buy that dream home in Steamboat….Do you personally take care of these exchanges?

No, Michael…I’m just a mortgage broker, but I know some great folks who can help people navigate this little challenge. If any of your viewers would like to get in touch with me to find out more information, they can contact me at: