Investing in Real Estate: 1031 Exchanges, Part III
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If you’ve been following along the past few days, I’ve been giving a primer course on 1031 exchanges. This common, but often misunderstood, tax code can help investors defer taxes from their real estate transactions. As more investors are profiting off of the foreclosures and short sales in the market, it’s never been a better time to brush up on the rules of Section 1031 of the IRS Code.
Make sure to read the previous posts for advice on timing, benefits, and exchange alternatives. The fourth and fifth important things you should know are as follows:
Plan proactively, not reactively. Many taxpayers do not contemplate using an exchange strategy until a few days prior to closing. While a qualified intermediary (QI) can certainly be engaged on such short notice, the timing challenges eliminate potentially beneficial proactive planning alternatives.
This can often prove difficult in situations such as asset sales by a partnership, whereby the partners within the partnership want to accomplish different tax and investing objectives, go their separate ways, restructure the partnership, and so on. It is recommended that taxpayers discuss exchange strategies with their tax advisors and QI well in advance of closing, thereby allowing adequate time to properly accomplish the desired exchange objectives.
Choose your QI wisely. Prior to 2007, a majority of taxpayers and their professional advisors did not ask many questions about the manner in which the QI held their exchange proceeds. Many assumed the QI was bound by state or federal regulations, much like the rules surrounding an attorney’s trust account.
Shockingly, QIs were not held to any such regulation and many taxpayers learned this lesson the hard way. Numerous QIs filed for bankruptcy from 2007-2009 for a variety of reasons and some were involved in illegal activities. As a result, the federal government and a handful of state governments have either enacted or are considering enacting laws that will regulate QIs.
In the meantime, taxpayers and their advisors should always consider the following:
As 1031 exchange volume continues to increase month over month, these concepts should help summarize key exchange fundamentals and new developments within the 1031 industry.
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Ricky B. Novak serves as president of Strategic 1031 Exchange Advisors (“SEA 1031”), an Atlanta based consulting firm and qualified intermediary that provides real estate and tax consulting services for clients structuring complex real estate transactions and asset dispositions. Contact Ricky Novak at www.sea1031.com .
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