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Selling Your Practice?

Consider a 1031 Exchange On The Real Estate To $ave Federal Taxes

Tax deferred exchanges are authorized under Section 1031 of the Internal Revenue Code. Basically, a tax deferred exchange is simply a method by which a property owner trades one property for another without having to pay federal income taxes on the transaction. In an ordinary sale, the property owner is taxed on the gain realized in the sale of the property, but in an exchange, the tax on the transaction is deferred until some time in the future. Future exchanges can occur to continue deferring the taxes.

Any exchange must be for “like-kind” property and is defined by the IRS as it relates to real property, “property held for investment or productive use”. This includes vacant land, residential rental property, commercial property, apartments or any real property that is not the exchanger’s primary residence. Any mixture of these types of properties can be allowed.

Exchanges do create some additional work in a sale and strict application of the IRS rules are necessary but by using a qualified intermediary, an exchange can happen in theory right up until closing on the sale. Though not ideal, it can be done even at the last minute so long as title has not passed to a buyer and money has not been received by the seller. Best results are achieved however, when sufficient time has been taken to plan the exchange. An exchange can also be set up as an “option” by setting up the documentation to give the seller the continued option of doing an exchange. It can also be cancelled, if the option to exchange is not desired or wanted. If you do cancel, however, expect a cancellation fee to be charged by the intermediary. Some sellers fear that the costs associated with an exchange are too high, but the costs for doing an exchange are generally fixed and known up-front, so it will be very clear whether the tax savings are significant compared with the costs of doing the exchange. As such, part of the tax savings pays for the fees associated with administering the exchange. You can also structure an exchange on part of the proceeds from a sale to defer some level of taxes that would be due and receive some cash from the transaction upon which taxes would be due.

Here are a few of the other possible benefits to you as the seller/exchanger:

  • Conserve equity by deferring tax on realized gain
  • Increase depreciable basis by acquiring property encumbered by larger debt
  • Acquire sheltered income by exchanging unimproved land for rental property
  • Reallocate basis by acquiring property with a higher building to land ratio
  • Acquire property without cash
  • Receive non-taxable cash by exchanging property which is later refinanced
  • Acquire property that is appreciating faster than the property transferred
  • Consolidate assets by exchanging many properties for one or a few
  • Diversify risk by exchanging one property for many
  • Conserve your estate by exchanging property throughout life instead of paying tax
  • Complete a transaction that would be difficult otherwise, due to tax consequences

If you are thinking of selling your practice, there are clear advantages to a 1031 exchange of the real property and it would be worth your time to talk with someone qualified to assist you. Contact your accountant to have them determine the taxes you could owe as a result of any sale. It will be helpful for you to know upfront what you could save and keep in your pocket, when considering whether an exchange is right for you.