Like-Kind Exchanges (1031 Exchanges)
A realized gain is a gain that results from selling property or an investment at a higher price then the original purchase price. Under the IRS Code, individuals must pay something called Capital Gain Tax the year that they realize such a gain. This tax can be incredibly high and if left unchecked would give property owners no incentive to sell and thereby cause s stalemate in the market. In order to prevent this from happening, the IRS has provided several exemptions, one of which is a like-kind exchange, often referred to as a 1031 exchange because of its location is Section 1031 in the U.S. Tax Code.
A like-kind exchange occurs when a person sells a piece of property and instead of putting that money into their bank account, or “realizing a profit” in IRS terms, they instead turn around and invest that money in another piece of property Specifically, a “like-kind” property.
Investors will typically invest in a Delaware Statutory Trust (DSTs) or a Tenant-In-Common investments (TICs). (Click our links for a full explanation of these products.)
While the Tax Code provides little, in fact no, definition of what a like-kind property is, we know there are a few criteria that must be met in order to qualify for this exemption. First of all, both properties must be held for use in a trade or business or for investment purposes. Your personal home or lake house won’t make the cut, unfortunately. Additionally both properties must be of the same nature, character and class. The quality of the property does not matter. For example, I could sell the first-class condominium I owned on the beach and exchange it for the lower income condominium downtown. The IRS won’t look into the quality or grade of the property exchanged.
There are also two time requirements that must be met in like-kind exchanges. First, you only have 45 days to sell the original property and identify potential replacement properties. That identification must be written and signed by you and deliver to someone involved in the exchange. Even notice to your lawyer, real estate agent or accountant will not meet this requirement. Second, the replacement property must be received and the entire transaction and exchange must be completed within 180 days pf the sale of the original property. In other words, you have 45 days to shop and show the IRS some options and 180 days to pick a winner.
Remember, a tax deferral is not tax avoidance. You will still have to pay taxes on your new property and it is essential that you or your accountant adjust and track the basis of the property correctly to comply with 1031 regulations.
What to do if You’ve Lost Money
Unfortunately, stock brokers have used 1031 exchanges as a means of earning themselves substantial commissions and income. For example, brokers and brokerage firms earn upwards of 10% of your investment when you allocate 1031 exchanges into TIC or DST investments. Prior to recommending these investments, the firms and brokers are obligated to perform due diligence and to only make suitable investment recommendations to their clients. In reality, brokers are often motivated by these hefty commissions and place their clients in TIC or DST investments that are doomed to fail.
If you have lost money in a 1031 exchange, a DST or a TIC investment, contact the securities attorneys at Fitapelli Kurta today for your free consultation. You may be entitled to legal compensation for your losses, but time is limited to file these claims, so do not wait. Call now.