(855) 378-3443
In a 1031 exchange, investors can defer capital gains taxes by reinvesting the proceeds from the sale of one property into another. However, to qualify for the tax deferral, investors must follow strict rules, including the requirement for an arm's length transaction. An arm's length transaction means that the parties involved are unrelated and act in their own best interests.
To ensure compliance, investors use a Qualified Intermediary (QI) who holds the proceeds from the initial sale in a separate account. The QI must be an independent party and cannot have a relationship with the investor. Additionally, the IRS imposes restrictions on related-party transactions within a 1031 exchange, preventing the sale of acquired properties to related parties for at least two years.
This rule aims to prevent basis-shifting and the avoidance of capital gains recognition by trading low-cost basis properties for high-cost basis properties with related parties.
To maintain the arm's length nature of the transaction, investors must utilize a Qualified Intermediary (QI), also known as an Exchange Accommodator. The QI acts as an independent third party who facilitates the exchange, holds the proceeds from the initial sale, and ensures that the transaction adheres to the necessary rules and timelines.
One crucial rule in a 1031 exchange is the two-year holding period requirement. If either party involved in the exchange sells the property within two years of the exchange, the IRS will disqualify the transaction, resulting in the recognition of capital gains and potential tax liabilities. This rule is in place to prevent taxpayers from abusing the exchange by quickly selling the acquired property for immediate financial gains.
However, there are exceptions to the two-year rule. The IRS acknowledges that certain circumstances may warrant an early sale without disqualifying the exchange. These exceptions include:
● Death of either party: If either the buyer or the seller passes away within the two-year holding period, the transaction will not be disqualified. The death of a party is considered an involuntary conversion and falls under an exception to the rule.
● Involuntary conversion: In the event of an involuntary conversion, such as property damage or destruction by fire, natural disaster, or condemnation, the exchange may be exempt from the two-year rule. The taxpayer must prove that the sale of the property was a result of an unforeseen and involuntary event.
● Non-tax avoidance motivation: If the taxpayer can demonstrate that the motivation for selling the property within the two-year period was not primarily driven by tax avoidance purposes, the exchange may still be eligible for tax deferral. The burden of proof lies with the taxpayer to establish a legitimate non-tax-related reason for the early sale.
It is essential to consult with a qualified tax professional or an experienced intermediary to ensure compliance with the arm's length rules and to navigate any exceptions that may apply. By following the guidelines and exceptions provided by the IRS, investors can effectively leverage the benefits of a 1031 exchange while adhering to the required rules and timelines.
The determination of Fair Market Value (FMV) is crucial in any real estate transaction. FMV represents the value of a property as determined by the marketplace, where an objective purchaser is willing to pay. To ensure that a transaction meets FMV standards, it must be conducted at arm's length, meaning both parties are unrelated and act independently.
In real estate, FMV is typically determined by analyzing recent sales of comparable properties in the same area. This approach helps establish a fair and objective value for the property. If comparable sales data is insufficient, an expert appraisal can be used as an alternative method to determine FMV.
However, if you sell your property to a relative or someone with a personal or business relationship, there is a risk that the transaction may not reflect FMV. This can occur when the seller has an interest in selling at a lower price, and the buyer has an interest in paying less than the property's actual worth. Such considerations can jeopardize the qualification of a 1031 exchange for deferring capital gains taxes.
Complying with the arm's length requirement is essential in 1031 exchanges to ensure that FMV is upheld. When parties involved in a transaction have a non-arm's length relationship, the transaction may raise concerns about whether it truly reflects FMV. By ensuring that 1031 exchange transactions adhere to FMV principles, investors can mitigate potential challenges related to qualification, particularly in non-arm's length situations. Seeking guidance from tax professionals and experts in real estate valuation can help ensure compliance with FMV standards and the arm's length requirement in 1031 exchanges.
General Disclosure
Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.
Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.
1031 Risk Disclosure:
· There’s no guarantee any strategy will be successful or achieve investment objectives;
· All real estate investments have the potential to lose value during the life of the investments;
· The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;
· All financed real estate investments have potential for foreclosure;
· These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.
· If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;
· Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits
Perch Financial LLC and Emerson Equity LLC do not provide legal or tax advice. Securities offered through Emerson Equity LLC Member FINRA/SIPC and MSRB registered. Emerson Equity LLC is unaffiliated with any entity herein. 1031 Risk Disclosure:
No offer to buy or sell securities is being made. Such offers may only be made to qualified accredited investors via private placement memorandum. Risks detailed in a private placement memorandum should be carefully reviewed, understood, and considered before making such an investment. Prospective strategies and products used in any tax advantaged investment planning should be reviewed independently with your tax and legal advisors. Changes to the tax code and other regulatory revisions could have a negative impact upon strategies developed and recommendations made. Past performance and/or forward-looking statements are never an assurance of future results.
Many of the investments offered will be only available to those investors meeting the definition of an Accredited Investor under SEC Rule 501(A) and offered as Regulation D private placement securities via a Private Placement Memorandum (“PPM”). Prospective investors must receive, read, and understand all the risks associated with buying private placement securities. Investments are not guaranteed or FDIC insured and risks may include but are not limited to illiquidity, no guarantee of income or guarantee that all tax advantages or objectives will be met and complete loss of principal investment could occur.
Risk Disclosure: Alternative investment products, including real estate investments, notes & debentures, hedge funds and private equity, involve a high degree of risk, often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. Alternative investment performance can be volatile. An investor could lose all or a substantial amount of his or her investment. Often, alternative investment fund and account managers have total trading authority over their funds or accounts; the use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. There is often no secondary market for an investor's interest in alternative investments, and none is expected to develop. There may be restrictions on transferring interests in any alternative investment. Alternative investment products often execute a substantial portion of their trades on non-U.S. exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in U.S. markets. Additionally, alternative investments often entail commodity trading, which involves substantial risk of loss.
NO OFFER OR SOLICITATION: The contents of this website: (i) do not constitute an offer of securities or a solicitation of an offer to buy of securities, and (ii) may not be relied upon in making an investment decision related to any investment offering by Perch Financial LLC, Emerson Equity LLC, or any affiliate, or partner thereof. Perch Financial LLC does not warrant the accuracy or completeness of the information contained herein.
