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Commonly asked investor question about 1031--Part 1.

In my experience, investors commonly ask many of the same questions when contemplating a tax deferred exchange.

Below are responses to some of the more common questions. Investors should be careful not to generalize and ask a lawyer and CPA for advice to determine how these guidelines apply to them.

Q: How long do I have to complete my exchange?

A: The exchange period runs from the date of closing on the sale of your relinquished property until the due date (with extensions) for filing your tax return for the year in which the relinquished property is sold or 180 calendar days, whichever is earlier.

Thus, the maximum amount of time one has to complete an exchange and take title to replacement property is 180 days.

Q: Can I identify more than three properties in my identification notice?

A: Yes, you can identify any number of properties. However, if you identify more than three properties, then your notice must either meet the 200% rule or the 95% rule.

The 200% rule states that an investor can identify any number of properties as long as the aggregate value of what is identified does not exceed 200% of the value of the relinquished property.

The 95% rule states that an investor can identify any number of properties as long as the investor actually acquires 95% of the identified properties. So, bottom line, one must either only identify three properties or fit within the 200% or 95% rule.

Q: Can I sign a contract to buy my replacement property before I sell my relinquished property?

A: Yes. The date of signing the contract is not relevant in an exchange. All time periods run from the date of transfer of title. So, as long as one actually sells and transfers title to one's relinquished property before taking title to the replacement property, it is possible to perform a delayed exchange.

Q: Can I take part of the sale proceeds out at closing and still perform an exchange?

A: Yes, any dollars you walk away with at closing are considered cash boot and taxable to the extent of your capital gain. Taking cash out at closing results in a partially deferred exchange.

If one needs cash however, one should consider reinvesting the entire proceeds from the sale in one or more replacement properties and thereby avoiding any tax liability for cash taken out. Thereafter, one can increase the financing on the replacement property and receive funds from the financing that are not subject to capital gain taxes.

Q: Can I apply both Section 121's tax exclusion applicable to my primary residence and Section 1031 at once?

A: Yes. The ability to perform what is commonly known as a split transaction is well documented. There are two basic types of split transactions. First, where at the time of sale the property is 100% investment or trade or business property but for two of the last five years it was an investor's primary residence.

The second type of split transaction is where at the time of sale part of the property is one's primary residence and part of the property is used in one's trade or business or held for investment (i.e. rented).

In the latter situation, it is necessary to allocate the gain between the two types of property before determining the dollars that must be spent to defer any remaining tax liability. For further guidance and many useful examples, see Rev Proc 2005-14.

Q: Can a trust perform an exchange?

A: Yes, any person or entity can perform an exchange provided it holds property for use in its trade or business or for investment. Thus, tax deferred exchanges are available to C and sub S corporations, LLCs, partnerships and individuals. However, with some limited exceptions, the same taxpayer must hold title to the property on both sides of the exchange.

Q: Can one trade property outside the US for property in the US?

A: Generally, no. Until 1989, such swaps were permitted. After 1989, only US property is considered like kind to US property and foreign property to foreign property. However, one PLR (PLR 9038030) permitted an exchanger to swap property in the US Virgin Islands for property in the US, declaring US Virgin Island property as like kind to US property.

The PLR was based on specific facts of the case, namely that the exchanger qualified as a Section 932 taxpayer as a result of having business operations in the US Virgin islands.

Thus, an exchanger seeking to exchange between the US and the US Virgin Islands should seek tax advice to determine if they would fit within the scope of the PLR.

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Title Annotation:INSIDER'S OUTLOOK; tax deferred exchange
Author:Michaels, Pamela A.
Publication:Real Estate Weekly
Geographic Code:1USA
Date:Feb 1, 2006
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