Tax Saving Investing

This article is meant to be an introduction on the subject of performing tax-deferred exchanges. There are various hoops that the IRS makes you jump through to complete a tax-deferred exchange, but they are actually not that complex once you study up on them a bit.

A tax deferred exchange allows us to sell a part of investment (i.e. rental), trade or business property, purchase a new property with the gain or profit from the sale, and not owe taxes on the sale immediately. If you ultimately sell the new piece of property, you would owe taxes at that time. Normally, all gains and losses on sales of real estate are taxable, but an exception lies wherever the property sold is traded or exchanged for "like-kind" property. The new property is seen as a continuation of the unique investment, so taxes do not owe at the time of the sale.

Many people view tax deferred exchanges as being for giant corporations, or only for professional investors. I consider that each one should take advantage of these where they can. Strategy -- purchase a rental dwelling below market value, rent it for a year, sell it, and buy two rental properties with your gain. Note that if you do this too many times, the IRS may take the view that you are not a long term investor, and prohibit such exchanges. When you get ready to do a tax-deferred exchange, you will require the services of a qualified CPA or Attorney. This is a basic opening only, and you should always get expert advice from someone who has all the particulars on your deal, since so much liability is at stake. In my course I list the company that I use for these real estate exchanges. They are a national company and can assist you out wherever you are in the country. I have used them for quite a few deferred exchanges, and they have been an excellent resource and extremely competent.

Let's look at how one of these deals would work. Imagine that you own a rental property that has gone up in value. You'd like to trade this property and then reinvest the proceeds into some other rental real estate. You can keep away from the tax bill if you can find suitable property to exchange for. The complexity of the tax deferred exchange is that the property you are going to buy must be identified within a certain amount of time, and it must be closed within a definite amount of time after it is identified. Unfortunately, no extensions are possible.

Identifying Property

You must recognize property in a written document signed by you, and delivered to the party support you with the exchange (cannot be related to you!) on or before 45 days from the date you sold the original rental property. There is a mounting body of support for classification of properties, and closing of new properties before the original property is sold. This is somewhat controversial and outside the range of this discussion.

Technical Note: You can recognize more than one property as the replacement property. However, the maximum number of substitute properties that you may identify without regard to fair market value is three properties. You may recognize any number of properties provided that the maximum value of these properties is not more than 200% of the value of the original property you are selling. Note that you don't have to shut on all the properties you identify. You can name several if you're not certain what will close, or not close, but you have to watch the rules in this technical note in terms of the value of properties you identify. If at the end of the recognition period you have identified more properties than you are allowed, you are normally treated as if no property was identified. This means that you pay taxes!
Time Limits For Completing the Exchange

If you have properly complied with the identification phase of the exchange, you have up to 180 days to complete an exchange, but the era may be shorter. Specifically, property will not be treated as like type property if it is received more than 180 days after the date you transferred the property you are relinquishing, or after the due date of your return (including extensions) for the year in which you made the transfer.

For multiple property transfers, the 45 day recognition period and the 180 day exchange period are determined by the earliest date a property is transferred.
Avoid Boot!

Boot is defined as any type or any money of property of not like kind (example, a car received as part of down-payment). You will be taxed on this boot in spite of of whether or not you carry out the exchange properly. You will want your Exchange Company, or attorney to look at your transaction closely to make sure you don't receive anything that could count as boot. Special rules apply for exchanging property with implicit mortgages.