If you are considering a tax shelter, 1031 Exchange is probably one of the best kept secrets in the Internal Revenue Code. Some consider it as the most overlooked potential opportunity to avoid capital gains tax incurred upon the sale of real estate property. Both the general public and many professionals who are uniformed or misinformed have overlooked this tax shelter opportunity.

1031 Exchange provides that if a business or investment property is sold and another property is purchased to replace it within six months, then the sale/purchase can be structured to be tax-free. In Washington DC, many properties have more than doubled in value over the past three years. Consequently, any DC property owners wishing to sell their property and take advantage of this exceedingly strong market will likely face a large capital gains tax burden when they sell their property. Deferred exchanges can be a very useful tool to investors seeking a tax shelter from the capital gains associated with the current market value appreciation.

A typical tax deferred exchange is very similar to a taxable sale transaction except that prior to closing on the property being sold, the "Qualified Intermediary" is assigned into the Sale Contract and instructs the closer to transfer the Exchanger's property to the buyer via direct deeding. The exchange proceeds (equity) are deposited into a separate exchange account to comply with the exchange requirement that the Exchanger is not in actual or constructive receipt of the funds at any time during the exchange. The exchange period begins with the transfer of the first property and allows the Exchanger 45 days to identify property and a total of 180 days to close on "like-kind" replacement property. The exchange is completed when the "Qualified Intermediary" is assigned into the Purchase Contract, uses the exchange proceeds to acquire the replacement property and instructs the closer to transfer ownership from the seller to the Exchanger via direct deeding.

NOTE: A "Qualified Intermediary" is a financial services group qualified with extensive legal experience qualified to process 1031 Exchanges and offers the size and financial strength necessary to ensure the security of the exchange process.

o Always discuss the intended exchange first with your legal and/or tax advisor.
o Call the 'Qualified Intermediary' of your choice prior to transferring the relinquished property.
o The 'Qualified Intermediary' will produce the necessary exchange agreement and other exchange documentation.
o Once an offer is accepted on the relinquished property, start looking for replacement property.
o Always insert a "Cooperation Clause" in the Sale and Purchase Contracts.

o Purchase equal or greater in net sales price (value).
o Reinvest all of the net equity in the replacement property.
o Obtain equal or greater debt on the replacement property.

Exception: A reduction in debt can be offset with additional cash, however, increasing debt cannot offset a reduction in equity.

MAKE SURE A 'COOPERATION CLAUSE' IS IN THE SALE CONTRACT

Sample Cooperation Clause for the Sales Contract

Buyer hereby acknowledges it is the intent of the Seller to effect an IRC §1031 tax deferred exchange, which will not delay the closing or cause additional expense to the Buyer. The Seller's rights under this agreement may be assigned to _____(name of your qualified intermediary)______, a Qualified Intermediary, for the purpose of completing such an exchange. Buyer agrees to cooperate with the 'Seller and _____(name of your qualified intermediary)______ in a manner necessary to complete the exchange.

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