Material courtesy of Realty Exchangers at http://www.irs1031exchanges.com/ProcedureManual.shtml
A tax deferred exchange allows us to sell a piece of investment
(i.e. rental), trade or business property, buy a new property
with the gain or profit from the sale, and not owe taxes
on the sale immediately. If you eventually sell the new piece
of property, you would owe taxes at that time. Generally,
all gains and losses on sales of real estate are taxable,
but an exception lies where the property sold is traded or
exchanged for "like-kind" property. The new property
is seen as a continuation of the original investment, so
taxes are not due at the time of the sale.
Many people view tax deferred exchanges as being for huge
corporations, or only for professional investors. I believe
that everyone should take advantage of these where they can.
Strategy -- purchase a rental home 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 disallow such exchanges. When you get ready to do a tax-deferred
exchange, you will need the services of a qualified CPA or
Attorney. This is a basic introduction only, and you should
always get professional advice from someone who has all the
details 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 help
you out wherever you are in the country. I have used them
for several deferred exchanges, and they have been an excellent
resource and extremely competent.
Let's look at how one of these deals would work. Assume
that you own a rental property that has gone up in value.
You'd like to sell this property and then reinvest the proceeds
into some other rental real estate. You can avoid the tax
bill if you can find suitable property to exchange for. The
difficulty of the tax deferred exchange is that the property
you are going to purchase must be identified within a certain
amount of time, and it must be closed within a certain amount
of time after it is identified. Unfortunately, no extensions
are possible.
Identifying Property
You must identify property in a written document signed
by you, and delivered to the party assisting 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 growing body of support for identification of properties,
and closing of new properties before the original property
is sold. This is somewhat controversial and outside the scope
of this discussion.
Technical Note: You can identify more than one property
as the replacement property. However, the maximum number
of replacement properties that you may identify without regard
to fair market value is three properties. You may identify
any number of properties provided that the total 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 close on all the properties you identify. You can name
several if you're not sure what will close, or not close,
but you have to observe the rules in this technical note
in terms of the value of properties you identify. If at the
end of the identification period you have identified more
properties than you are allowed, you are generally treated
as if no property was identified. This means that you pay
taxes!
Time Limits For Completing the Exchange
If you have correctly complied with the identification phase
of the exchange, you have up to 180 days to complete an exchange,
but the period may be shorter. Specifically, property will
not be treated as like kind 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 identification
period and the 180 day exchange period are determined by
the earliest date a property is transferred.
Avoid Boot!
Boot is defined as any money or any type of property of
unlike kind (example, a car received as part of down-payment).
You will be taxed on this boot regardless of whether or not
you carry out the exchange correctly. You will want your
exchange company, or attorney to examine your transaction
closely to make sure you don't receive anything that could
count as boot. Special rules apply for exchanging property
with assumed mortgages.
Summary
The tax-deferred exchange is a great way to maximize your
wealth. By keeping your investments growing without immediately
paying taxes, you can do wonders for your net-worth. You
will need to search out a good intermediary. I am happy to
provide the name of mine for our members. This may seem like
a dry subject, but it is important to understand when you
begin to accumulate some rental properties.
Remember that this article is to provide basic information
only. If you are planning on doing a tax deferred exchange,
you really need to speak with a professional that handles
these transactions on a regular basis. Information here is
subject to change by IRS regulations or statute, so be sure
to use current information provided by your accountant or
other professional when planning a strategy involving tax
deferred exchanges.
Buying Fixer uppers
Ask many a home buyer about the type of house they are looking
for and many will reply "We are looking for something
we can fix up and live in (or resell). We like the idea of
gaining some quick sweat equity." The classic "fixer-upper" home.
Unfortunately, there is a bit of fantasy in the notion, though.
First of all, there are many more fixer-upper buyers than
there are fixer-upper properties. Second, the current thinking
in many minds is that anyone can make a killing in the Real
Estate market, which is not always the case. Third,
many buyers totally mis-estimate both the cost and the time
involved in fixer-uppers, severely impacting (and in some
cases destroying) the profit potential. Unless you are fully
prepared to deal with the realities of fixer-uppers rather
than the fantasies, it probably is a good idea to look elsewhere
for a home.
This does not mean that there isn't equity to be gained
(or profit to be made) by purchasing the RIGHT property at
the RIGHT price. The important notion is to understand that
there are several factors that will make the difference between
winning and losing in such a transaction.
The Mindset
The first factor that must be understood is that it isn't
going to be easy. The only people who think that finding,
buying, fixing and selling a home is an easy task are those
who have never done it. Those with any experience (even if
only once) will tell you that it rarely is as simple as it
appears. In general, it is best to assume that repairs will
cost twice what you estimated, take double the amount of
time and,when finished, the house will be worth less than
expected. If you keep that in the forefront of your thinking,
the chances of being burned are much less.
Foreclosure sales are often good sources for fixer-upper
properties. A couple of resources that specialize in listings
of those types of homes are and . All three of the resources
above offer free trial periods to evaluate their services
and search for foreclosure listings in the area in which
you are interested.
Start Out Small
Some of the worst examples of mistakes made by buyers of
fixer-uppers are first-time buyers who bite off way more
than they can chew. Examples of this are houses that have
structural problems or will take an exceptionally long time
to repair, or are located somewhere other than a desirable
neighborhood. These can be a horrible drain on finances,
time and peace of mind.
A much better strategy for the inexperienced is to purchase
a home in a desirable neighborhood that is in need of cosmetic
attention--new paint, carpeting, appliances, landscaping
and the like. These repairs can either be handled by the
homeowner or are easily contracted out, saving time, effort
and money. Yes, money can be made on homes needing major
renovations, even if they
are in less popular neighborhoods, but these are jobs for
professionals, not homeowners (and definitely not for first-time
homeowners!)
Avoid Surprises
The most expensive situations are often those that are the
least expected--those nasty little (and often big) surprises
that jump out at you. You can avoid many of these surprises,
though, with a couple of easy steps taken BEFORE final commitment
to a property.
1) Have the property thoroughly inspected. Have the inspector
detail all obvious (as well as potential) defects in the
property. NOTE: The seller may say "we are selling the
house as-is, so NO inspections." Avoid this property
like the plague.
2) Run the numbers. You must know the market values for
houses in the neighborhood in which you are interested that
need no repairs. Running the numbers means working them backwards
to see how much equity or profit may be available (or even
IF there will be any) in the deal. You will need to begin
by computing the realistic value of the home when all repairs
are made. From that point, you will need to subtract any
selling expenses you will incur (commissions and the like)
as well as the full cost of repairs and, most importantly,
the amount of desired profit or equity.
Example:
$600,000: Expected Sale Price, Repaired
-40,000: Selling Expenses
-25,500: Repair Expenses
-50,000: Desired Profit/Equity
$485,000: Maximum Property Purchase Price
Don't be deluded into thinking that you'll be able to sell
for more than the market value or do the repairs for less
than the estimates. If the numbers don't fit--with a good
amount of "wiggle room" for more expense or handling
costs or if the property does not sell quickly--don't waste
your time or your money!
Summing Up
When considering a fixer-upper, whether for resale or to
live in with increased equity, go into the process fully
prepared so you will avoid many surprises. For your first
project, only consider structurally sound homes in good neighborhoods
requiring cosmetic repairs only. Have any property you are
considering fully inspected and then get firm estimates for
all needed repairs. Most importantly, "run the numbers" to
be certain that the potential for gain is truly there. If
you are satisfied on all counts, you may very well be able
to be successful with your fixer-upper project “Remember
not making a decision is still a decision!
