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Rather than selling your commercial property outright, you may be considering a 1031 tax-deferred exchange of properties. This strategy can increase the amount you may subsequently borrow and also relieve you of the immediate burden of state and federal taxes you would be required to pay from selling outright.
Just be sure you handle the exchange with care from the start:
Make certain that both properties qualify for trades.
The 1031 Tax Deferred Exchange program only applies to properties that are used for trade, business or investment in some way. You can't use your primary residence or any other real estate considered to be for your own personal use.
The property that you acquire in the trade must also be used for trade, business or investment. You don't necessarily have to trade an office building for an exact replica of that office building, but you do need to be certain that both properties are like-kind. You may trade an apartment building for a strip mall, or a rental home for vacant land, but all properties must meet the like-kind test as mandated by the IRS.
The quality or condition of the properties is not a concern, but the location is, since only qualifying commercial real estate in the U.S. is considered like-kind to other commercial property in the U.S. If you want to use the 1031 program to defer taxes on foreign real estate, you'll have to trade foreign property for other foreign property.
Understand the fine print.
Whatever agreements you work out between property owners or investors, you must be certain to have a third party hold the proceeds of sales until the deal is finalized. Hire a qualified intermediary for this purpose to be certain your interests are protected. Expect to pay the intermediary $300 - $700 in fees.
Also understand that there is a time limit, and it's written in stone. You have 45 days after you sell your property to identify the property or properties you plan to acquire, and there are strict requirements on the number of properties and their valuation which you may identify. There are no extensions available for a 1031 exchange.
You're given 180 days to finalize the trade and take possession of the new property, and it must match the identifying descriptions as noted in the 1031 intent letter you sent to the other seller and your qualifying intermediary.
1031 Tax deferral doesn't eliminate taxes, but it does delay them significantly, allowing you to increase your real estate holdings before being liable for taxes on capital gains. The process is complicated and multi-faceted, so you must consult with a qualified commercial real estate attorney to avoid making a mistake that might incur immediate tax liability.
Share7 December 2015