GREC REnews, Vol. 4, Issue 9 (Sept. 2008)

GREC
Volume 4, Issue 9
2008 Dates to Note September 23, 2008
GREC Brokerage Course Empire Board of Realists September 24, 2008 GREC Trust Account Empire Board of Realists October 23, 2008 GREC Brokerage Course Northeast Georgia Board October 24, 2008 GREC Trust Account Class Northeast Georgia Board
GREC Disciplinary Sanctions
INSIDE THIS ISSUE:
Exchange Basics 1-2 Resources on Exchanges 2
Focus on Terminology:
"Investment"
Georgia Real Estate Commission Suite 1000 International Tower 229 Peachtree Street NE Atlanta, GA 30303-1605 Phone 404-656-3916

Georgia Real Estate Commission
GREC RENEWS
September 2008
Tax Deferred Exchanges:
What a Licensee Should Know
When a property owner sells an investment property, he/she wants to avoid paying taxes on the gain as much as possible. The most common method to do this is to enter into a tax free exchange. The title is somewhat of a misnomer as it is not really tax "free," but more accurately described at taxdeferred. It is also referred to as a 1031 Exchange, a tax deferred exchange, a Starker delayed exchange or a like kind exchange.
If any type of investment property is traded for another investment property the tax on any gain on the sale is avoided. For example if a seller stands to gain $250,000 on the sale of an office building, and he/she is truly an investor, he/she will probably be purchasing another investment property and will use that gain to "trade up" his/her equity. This ability to transfer that gain into a more valuable property is an excellent way to increase the value of the investor's portfolio.
There are some important rules that must be followed in order to qualify for as a tax deferred exchange. In 1939 Congress passed a law that enabled like kind exchanges and the Internal Revenue Code 1031 specifies the conditions required to avoid the tax liability on the gain.
Although this article describes the basic idea and reasons for doing exchanges, the licensee should always refer the client or customer to a specialist who can handle the exchange transaction. The licensee is not an expert in exchanges and should not try to be one.
There are companies and individuals that can act as a Qualified Intermediary and handle the actual transaction for the seller. These parties hold any earnest money or other funds involved in completing the transactions as well as the documentation necessary to meet IRS codes. It is imperative that the funds be handled properly so that the seller avoids some unanticipated tax on the sale. It is critical that the party handling the exchange is well versed and experienced in exchanges. There are companies that only perform exchanges and do nothing else.
Some of the basic requirements of an exchange are briefly described below: The properties to be traded must be of Like Kind. Like is broadly defined
as any type of investment property. For example a tract of land could be traded for an office building. Strict time limitations must be met in order to qualify for the tax benefits of the exchange
o The seller has only 45 days to designate up to 3 properties that will be purchased for the exchange. Certain documentation must be available to the IRS regarding the identification of these properties.
o The seller has only 180 to close on the transactions. The 45 days is included in this 180 day period. continued on page 2... 1

Georgia Real Estate Commission Suite 1000 International Tower 229 Peachtree Street NE Atlanta, GA 30303-1605 Phone 404-656-3916
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Exchange Basics...

Volume 4, Issue 9 September 2008

...continued from page 1

In addition to strict requirements for the exchange itself, the property

owner must maintain records regarding the transfer of funds and the

depreciable basis of the property for future evaluation once the acquired

property (properties) is sold.

As noted earlier, the tax is avoided but not "free." "When

the

replacement property is ultimately sold (not as part of another exchange), the

original deferred gain, plus any additional gain realized since the purchase of

the replacement property, is subject to tax." (Source http://www.irs.gov)

Commercial real estate sales often involve an exchange. In fact most

companies prefer to do an exchange on every sale if they own real estate. The

licensee needs to understand the basic exchange concept but should not

attempt to provide counsel or advice on the mechanics of the exchange. There

are professionals that deal only in exchanges and there are numerous

resources online for the licensee to become versed in describing the basic

reasons for doing an exchange of real estate.

Resources on Exchanges
1. Internal Revenue Code 1031 o http://www.irs.gov and IRS publications Publication 544, Sales and Other Dispositions of Assets Form 8824, Like-Kind Exchanges (PDF) Form 4797, Sales of Business Property
2. Title Companies 3. Attorney experienced in tax issues and real estate transactions 4. Intermediary company or exchange facilitator 5. Trade Associations such as the Federation of Exchange
Accommodators at http://www.1031.org/

Focus on Terminology: "Investment"
The word "investment'" can mean many things to many people. Generally the word investment is defined by Webster's as "the outlay of money for income or profit." The following is the Internal Revenue Code definition of Investment Property: This is property that produces investment income. Examples include stocks, bonds, and Treasury bills and notes. Property used in a trade or business is not investment property."
In the real estate industry it is meant to describe a real property that provides a return on the money invested. This return could be in the form of a realized appreciation in value or income generated from the property on a regular basis or both. By definition, the term investment implies a profit or return of some sort on money paid out. So savvy investors use techniques such as the tax deferred exchange to maximize their return on investment.
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