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Friday, August 1, 2014

1031 Tax-Deferred Exchanges

Source: MB Financial Bank
By Arnold M. Brown, Senior Managing Director, Head of 1031 Tax-Deferred Exchange Services, & Richard S. Witek, Senior Advisor, Trust Special Assets

Taxpayers who are contemplating exchanging real estate or personal property can defer the capital gains taxes from the sale of the relinquished property if they are replaced with like-kind assets as provided in Section 1031 of the Internal Revenue Code.

These exchanges are known by several names, including like-kind exchanges and the more frequently used Starker exchanges. The beauty of using Section 1031 is that it permits the taxpayer to avoid capital gains tax on the increase in value of the property being exchanged.

Real estate tax-deferred exchanges have been allowed under the Internal Revenue Codes since the 1920s. However, it wasn’t until the Starker v. United States lawsuit in 1979 that taxpayers could do a non-simultaneous exchange of real estate. The only problem was that the Internal Revenue Service (IRS) had not prescribed any rules or regulations advising taxpayers on how to proceed with Starker exchanges.

The IRS issued final regulations providing codified provisions on how to do exchanges in 1991, and nine years later, issued Revenue Procedure 2000-37 which recognizes the use of “reverse” like-kind exchanges. Up until then, the IRS rules pertained only to forward exchanges, or exchanges in which the old or relinquished property was sold by the taxpayer, who then acquired the new or replacement property.

So, how does the taxpayer actually do an exchange? In doing a forward exchange:

  • The taxpayer first sells his or her old or relinquished property.
  • The taxpayer then identifies new or replacement property within 45 days of the sale of the old property and, generally speaking, closes on the purchase of the new property within 180 days of the sale of the old property.

As a Qualified Intermediary (QI), MB Financial Deferred Exchange Corporation, a wholly-owned subsidiary of MB Financial Bank, would hold the proceeds from the sale of the relinquished property until directed by the taxpayer to pay out the proceeds to acquire the replacement property.

It’s important to choose to work with an experienced QI because the QI will help ensure you receive the full benefit of an exchange by providing documented transactions to meet IRS requirements, complete segregation and protection of client funds, payment of interest earned on proceeds from exchanges, and policies and procedures that are reviewed periodically by federal regulators.

In working with a QI, the taxpayer in effect never receives the relinquished property sale p

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