Real estate investors often want to exchange one investment property for another, commonly referred to as the replacement property. Often, the real estate investor wants to remain fully invested in the investment property and defer paying any capital gains taxes due on the sale of an investment property. This is commonly referred to as a 1031 tax-deferred exchange or a tax-deferred exchange. Sometimes erroneously called a “tax-free exchange”, this type of transaction does not eliminate the taxes due, only defers payment of the taxes until the replacement property, or any subsequent replacement property, is sold.
While this a brief overview of the requirements for a tax-deferred exchange, the process legal and tax implications, and sellers should consult with competent legal counsel and an accountant before considering a tax-deferred exchange. Metropolitan Title can assist investors by providing referrals to appropriate legal and accounting professionals who can provide advice regarding the contemplated transaction. This overview is not intended to be a substitute for the advice of an attorney or tax-specialist.
In order for a transaction to qualify for a tax-deferred exchange, several factors must apply:
• The property being sold, called the “existing property”, and the property being purchased, referred to as the “replacement property”, must be investment properties and not the owner’s primary residence, vacation home, or second home.
• The net proceeds from the sale of the existing property must be 100% reinvested into the replacement property. The total mortgage debt on the replacement property must be equal to or greater than the mortgage debt on the existing property.
• The seller of the existing property must be the same as the purchaser of the replacement property. For example, cannot sell a property held in a partnership and purchase the replacement property as an individual.
There are also additional costs associated with this type of transaction. The purchaser of the Existing Property incurs no additional costs for cooperating with the investor in effecting the tax-deferred exchange. The seller of the Replacement Property will incur no additional charges for cooperating with the investor. However, in addition to the normal settlement costs the investor will incur additional costs. Please contact Metropolitan Title for the appropriate fees.
• A law firm will charge for preparation of the documents necessary for the property exchanges. Metropolitan Title usually refers the document preparation to the Law Office of James E. Mitchell, III, PLC, although investors may use other counsel if they so desire.
• A title company will charge a fee for acting as the Exchange Agent/ Third-Party Accommodator/Qualified Intermediary, unless the owner picks another company to act as the Qualified Intermediary.