Law Office of Marc L. Weber

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(949) 543-0800

Law Office of Marc L. Weber

If it is the purchase of a single-family home, you can use the standard agreement provided by the real estate agent, provided that you actually read it. You may wish to call an attorney and ask questions about what the contract means. Beyond that, once you start looking at an investment property, income property, multi-family, or any commercial property, you should not use the standard agreement. Those documents are full of all sorts of landmines for the unwary and they are essentially designed to protect the brokers more than the clients.

What Is A 10-31 Exchange? How Do I Know If I Qualify For It?

A “1031 exchange” is a specific real estate transaction under the Internal Revenue Code and some additional Internal Revenue Regulations. Under recent law, this exchange is now limited to the real property alone and does not extend to other types of property, like businesses. Simply put, a 1031 exchange is when, if you sell a property and you designate a replacement property, and you close escrow on a replacement property within a certain period of time, and you (in general) do not take money back from the sale, any capital gain which you would have otherwise had to recognize and treat as income on your tax return, is deferred.

Deferred means delayed, not eliminated. Any amount that you take out of the escrow upon closing is called “boot”, meaning taxable. If you took all the money out of escrow, then there would be no 1031 exchange, even if you subsequently bought another property. A third party, who is not the taxpayer, a relative, or their attorney, accountant, or real estate agent, holds the proceeds of the first sale. This is critical and it cannot be the escrow, even though the holder may be a company that is owned by the same people who own the escrow. That third party is called the accommodator and when you are ready to close on the new property, the accommodator will transfer the money that it held into the second escrow. It may be necessary to add additional money to complete the purchase of the new property because frequently the cost of the second property is more than the sale proceeds of the first property.

A technicality most people do not know is that 45 days after the close of the first escrow, the taxpayer must designate up to three replacement properties. The taxpayer does not have to close escrow on all of those, but the taxpayer must name up to three properties. The 45 days are calendar days; they are not business days and there is no grace period.

Assuming that you have designated the property, and signed a new purchase agreement, you are now in escrow for the second property. The second escrow must close 180 calendar days after the first escrow. The IRS does not like 1031 exchanges and so the rules are construed strictly. It is a benefit and a privilege, and therefore, you have to play by all the rules. Another important rule, of which most people are unaware, is that when you buy a second property and you receive the benefit of the deferred tax, your new property has an investment cost, called “basis”. That investment cost is used in determining how much the land is worth, how much the building is worth, and how much of the cost can be depreciated.

The investment cost of the new property is reduced by the amount of the gain that was deferred in the first sale. This means that you have a reduced investment price in the new property. Therefore, if you sell that new property, you may have more capital gain than you would expect. Likewise, if you want to depreciate the building, you do not get as much depreciation as you would expect because your investment cost was reduced by the gain deferred on the first sale.

For more information on Using A Standard Listing Agreement or Not, a free initial consultation is your next best step. Get the information and legal answers you are seeking by calling (949) 543-0800 today.

Marc L. Weber

Call Now For A Free 20 Minute Consultation
(949) 543-0800