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Monday, March 20, 2006

1031 Do’s and Don’ts By Lorraine Stuart Merrill:

Section 1031 of the Internal Revenue Code contains serious tax benefits for property owners who qualify—and who plan before they leap into a sale. “Even though this is an old law, enacted by Congress in 1921, only a relatively small number of people utilize it,” notes Tom Torsney, senior vice president of TIMCOR Exchange Corporation, a national qualify¬ing intermediary. “With less tax to pay, more money can be reinvested into more valuable property. It’s one of the last great tax breaks,” Torsney declares. “It is a means of building wealth, using undiminished gains to reinvest into more valuable property.” A Section 1031 exchange is not a do¬it-yourself project. The IRS has rigid specifications, including the use of a qualifying intermediary (QI) to hold the property and money until the exchange is completed with acquisition and transfer of the replacement property. Consult with a financial planner or tax account¬ant, and find a reputable professional QI before you sell. Follow these basic rules for

1031 exchanges. DO:

Plan ahead to meet all requirements of Section 1031.
Establish a rental history for vacation home property. The IRS has not set a firm rule, but attorney Richard Lipton, tax partner with Baker & McKenzie in Chicago, advises a minimum two years of rental his¬tory, prefers five years.
Report change of use from personal to rental/investment to IRS by filing return showing rental income, expenses. “The biggest trap taxpayers fall into is to not establish a paper trail,” advises Scott Saunders, senior vice president of Asset Preservation, Inc.
Secure the services and advice of a rep¬utable and knowledgeable attorney, tax accountant, and qualified intermediary.
Make sure a reputable qualified inter¬mediary holds all funds and title until the exchange is completed.
Identify replacement property within 45 days of date of transfer of property being relinquished in an exchange.
Have the replacement property transferred to exactly the same ownership as the relin¬quished property.
Complete the exchange within 180 days of transfer of relinquished property.


Use a home for personal use more than 14 days a year, or ten percent of annual total occupied days, for at least one year. Two or more may be safer.
Select replacement property of lesser value than the relinquished property, unless prepared to pay taxes on the ‘boot’ or difference in value.
Allow a relative or personal agent such as attorney, realtor, or accountant to act as the intermediary, because IRS will not qualify such an agent as independent.
Take control of proceeds from relinquished property or title of acquired property at any point before the exchange is completed.
Use 1031 exchanges for ‘flipping’ rental properties. Property held primarily for sale, vs. investment, does not qualify, warns Jon Christianson, vice president and general counsel for Asset Preservation, Inc.
Wait for an audit to try to establish investment or rental use of exchange property.

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