Frequently Asked Questions

Title Insurance FAQ

What is title insurance?

When you buy property, you want to be sure that no one else
has an ownership, interest, or claim on your new property. Title insurance gives you that peace of mind. Title insurance does not guarantee that title defects do not exist, but instead protects you from claims against your property if defects covered by the policy are later discovered. You pay a one-time premium for a title policy and the coverage remains effective as long as you own the property.

For lending institutions, title insurance provides protection against the loss of the loan amount resulting from a defect in a title. Because the risks are different, lenders are often given coverage that owners are not. A lender's coverage terminates when the loan is paid off.

Should I buy a title insurance policy?

Absolutely. When you buy property, you want to rest assured that the property will be yours and that no one else will have liens, claims or encumbrances against your property other than those disclosed to you or arranged by you (such as a mortgage). Title insurance helps prevent the potential loss of your property due to these issues. If you are buying or selling property, having a title policy protects the transaction and gives everyone involved peace of mind.

Is title insurance worth the cost?

Yes, title insurance is one of the best insurance values available. The premium you pay is based on the purchase price of your property and rates are regulated by each state. You pay only a one-time premium when you purchase your policy and this coverage lasts as long as you own your property — and will protect you even after you sell your property.

Title insurance also covers payment of legal costs to defend your title and payment of all covered, claims up to the face amount of the policy.

Property owners in many states can take advantage of a “simultaneous issue rate”. When a lender's policy is purchased at the same time as the owner's policy, its cost is included in the owner's policy premium without additional charge.

Is there a difference between a lender's policy and an owner's policy?

Yes. A lender’s policy protects the money they have loaned for the purchase of a property, and their coverage expires when the load in paid off. Virtually all lenders require a lender’s policy to protect the money they have loaned to purchase a property.

Through an owner’s policy, a buyer obtains additional protection that covers the owner’s interests exclusively. Coverage includes protection of the total purchase price, and the policy remains effective as long as the buyer owns the property.

How does title insurance work?

Most types of insurance are “assumption of risk” forms of coverage and cover specific events that take place in the future. Title insurance is a “risk elimination” form of coverage and looks backwards to cover certain unknown events that may have taken place in the past.

A title policy insures an owner or lender against loss or damages arising out of defects to or liens on titles which are not disclosed in the title policy and that occurred prior to the issuance of the policy. Title searches uncover many of these issues, and known risks found in a search are addressed — thus the term “risk elimination”. 

However, there are some defects that may not be discovered in even the most diligent title search. Title companies assume the liability for these hidden defects thereby protecting you against:

  • Financial Loss — The title insurer is responsible for covered claims against your property, up to the face amount of the title policy
  • Legal Cost — The title insurer pays to defend your title against a covered claim

If a claim is made against your title, your title insurer takes care of it for you. This includes negotiating the claim, defending the claim in court, all legal costs incurred, and paying the amount necessary to satisfy the claim.

What problems can arise with a title?

There are virtually no perfect titles. Government restrictions, utility easements, claims of adverse possession, and tax liens are examples of limitations, or defects that can impact a title. Title searches disclose many of these limitations or defects. However, there are some that may not be discovered in even the most diligent title search. Examples of such defects are:

  • Forgery, false impersonation, and incorrect legal descriptions
  • Deeds delivered after death, deeds from incompetent persons or minors, or deeds not properly delivered
  • Misinterpretation of wills, deeds, or marital status of grantor
  • Wills not properly probated or undisclosed or missing heirs
  • Mistakes in recording legal documents
  • Record defects, liens, encumbrances, adverse claims or matters not known or disclosed to the new owner that attach before the date of policy
  • Lack of legal right of access
What types of claims are generally covered by title insurance?

The following are types of claims that are generally covered by a title policy.

  • Forged documents, such as deeds and wills
  • Fraud
  • Lack of competency, capacity or legal authority of a party
  • Conveyances not joined in by a necessary party—i.e.: spouse, heir, corporate officer, managing member
  • Unsatisfied mortgages or record
  • Incomplete or erroneous probate or lack of probate
  • Mistakes in legal descriptions or recording errors
  • Deed not properly recorded
  • Judgments or liens against a prior owner or the property
  • Unpaid real estate or inheritance taxes

If a claim is made against your title, your title insurer takes care of it for you. This includes negotiating the claim, defending the claim in court, all legal costs incurred, and paying the amount necessary to satisfy the claim.

If my lender gets title insurance for my mortgage, why do I need a separate policy for myself?

The lender’s policy only insures the lender's interest, covering only the amount of the mortgage loan — which typically is not the property value. Lender’s coverage also expires when the loan is paid.

Buyer’s coverage protects your total purchase price, and the policy remains in effect as long as you own the property or have any liability to future owners based on the warranties of title you make when you sell the property. In addition, in the event of a claim, there is no provision for payment of legal expenses for an uninsured party. So, without a buyer’s policy you are responsible for your own legal costs.

1031 Tax Deferred Exchange FAQ

What is a 1031 Tax Deferred Exchange?

When you sell property, you generally have to pay tax on the gain. Section 1031 of the Internal Revenue Code allows a taxpayer to defer the tax normally due on the sale of property held for investment or used in business or trade when the sale property is exchanged for another “like-kind” investment property. These exchanges provide opportunity to preserve and grow holdings.

Why do I need a qualified intermediary?

IRS regulations have defined several “safe harbors” that help establish the boundaries for exchanges. As long as your transaction is structured within these boundaries, it is generally presumed that your exchange will be allowed.

Having a qualified intermediary (QI) hold the proceeds of your sale is one of these safe harbors. You cannot have actual or constructive control of any of the proceeds received from the sale of your property, nor can you leave them in an escrow account. As long as you have a QI, such as this agency, hold the proceeds from your sale, you have complied with that requirement. The QI cannot be your attorney, accountant, real estate agent or a related party.

To comply with IRS requirements the proceeds from the sale of your property are delivered directly to the QI. When you are ready to close on your replacement property, the QI then transfers these proceeds to the seller.

A successful 1031 Exchange relies upon the proper completion of documents, a timeline strictly followed, and a taxpayer who has been informed of all the options available for his particular situation.

How does a 1031 Tax Deferred Exchange work?

You should always discuss the applicability of a 1031 Exchange with your legal or tax advisor. Before transferring the property you are selling, contact your local title and settlement agency to be your qualified intermediary (QI). Your QI will produce the required exchange agreement and other important documentation that must be in place before you transfer your property.

Once an offer is accepted on your property, immediately seek replacement property. There is a 45-day time frame during which the replacement property must be identified. Insert a “cooperation clause” in both the contract to sell and the contract to purchase. Within 180 days of the transfer of the relinquished property, the closing on the “like-kind” replacement property must occur.

Once you sell your initial property, your qualified intermediary deposit the proceeds in an interest bearing account at a bank of your choice until they are needed to buy your replacement property. Then, at your direction, your QI use the proceeds to acquire the like-kind replacement property you have selected.

What are the advantages?

There are many advantages to a 1031 Exchange, whether you are an individual with one rental house or a corporation with a shopping center. The primary advantage is that you may sell property without incurring any immediate tax liability. You may then use these tax-deferred proceeds to invest in another project. That keeps the money you would have paid in taxes working for you.

Suppose you are the owner of raw land that produces no income and you exchange it for income-producing property. Your advantage is cash flow. Suppose you have held this land after the appreciation has peaked. You can start rebuilding equity by exchanging it for new property.

A commercial property might be exchanged for industrial and residential rental property, giving you diversification. Exchanging multiple rentals for a single-user commercial property can provide management relief. You could trade up to a better neighborhood or for something closer to home.

How must the exchange be structured to avoid immediate tax?

You must reinvest all the proceeds from the sale of your property and purchase the new property of equal or greater value to avoid paying any capital gains tax. You must also replace any existing debt with an equal or greater amount of debt. Any proceeds not reinvested in the replacement property and/or any debt relief is considered “boot” and will be taxed.

Following are two simplified scenarios (ignoring the effects of depreciation) that illustrate these rules.

Illustration 1
 SalePurchase Boot
Sale Price $450,000 Purchase Price $600,000  
Minus Debt $-200,000 New Debt -$380,000 0
Minus Cost of Sale -$30,000      
Exchange Proceeds $220,000 Down Payment $220,000 0


Since the seller acquired $180,000 more debt and reinvested all the net equity, the exchange is fully tax-deferred. The tax that he would have paid on a straight sale of this property can go towards the purchase price of his replacement property in a 1031 Exchange.

Illustration 2
 SalePurchase Boot
Sale Price $450,000 Purchase Price $360,000  
Minus Debt $-200,000 New Debt $160,000 $40,000
Minus Cost of Sale -$30,000      
Exchange Proceeds $220,000 Down Payment $200,000 $20,000
Total Boot -$30,000     $60,000

Since the seller acquired property with only $160,000 of debt, there is $40,000 of mortgage boot. Also, he did not reinvest $20,000 of the net equity, which resulted in $20,000 of cash boot. The combined amounts of $20,000 and $40,000 equal $60,000, which is taxable boot.

It is important to understand that a Section 1031 exchange is just that, an exchange of one property for another. It is not a sale and re-investment, a transaction that will result in taxable capital gains.

Are there any disadvantages?

There are three primary disadvantages:

  1. You may not use any of the net proceeds from the sale of your property for anything except investing in the replacement property, without tax consequences.
  2. If you identify property that you want to buy, but decide after day 45 that you don't want it, your qualified intermediary (QI) must still hold the proceeds until the 181st day. Returning the funds before then would be an early disbursement and contrary to the exchange agreement entered into between your and your QI.
  3. You will have a reduced basis in your replacement property, resulting from the carry-over basis of the property you sell. If you eventually sell the replacement property, you will realize more gain than if you had acquired the property through a straight sale and purchase.
Will I have to pay the deferred tax later?

If you eventually sell the replacement property outright, rather than completing another 1031 Exchange, you will be required to pay capital gains tax on the replacement property.

If you keep the replacement property indefinitely, under current law, the tax liability that would be incurred with an outright sale is forgiven at your death, as your estate doesn't have to pay taxes on the gain.

Your heirs get a stepped up basis on the inherited property. Their basis is the fair market value of the inherited property at the time of your death or six months later, whichever they choose.

What is like-kind property?

“Like-kind” property does not mean “same-type” property. All real property is like-kind with all other real property. Any real estate held for investment or business can be exchanged for any other real estate to be used for investment or business. For example, you may exchange a rental house for a shopping center or undeveloped land for an apartment building.

You must hold your property for investment or for productive use in your trade or business to qualify for Section 1031 treatment. The critical issue here is your purpose in holding the property — how you intend to use the property — rather than the type of property.

What property does not qualify?

Residence or second home: You may not exchange your residence or second home, nor may you acquire as your replacement property a house to be used as either. You could “convert” your second home to a valid exchange property and establish this intent by properly renting it and holding it as a legitimate rental property. Consultation with a tax advisor is important if you change how you intend to hold the property.

Primarily for sale: The intent to hold property “primarily for sale” will prevent it from qualifying for 1031 Exchange treatment. Most properties owned by developers, builders and people who perform rehabilitation work are held primarily for sale and may not be the subject of an exchange. When these properties are sold, they are subject to ordinary income taxes rather than capital gain taxes.

Other: Partnership interests, notes secured by real property, contract vendor's interests and foreign property do not qualify.

Should I buy a title insurance policy?

The IRS does not require that the exchange happen simultaneously, and, indeed, from a practical standpoint, that is often difficult to arrange. You have 45 days from the date of closing on your property to identify your replacement property or properties. From the date of closing, you have the earlier of 180 days after the transfer of your property or the due date of your federal income tax return (including extensions) to close on the property or properties you identified.

Timeline
Start45 days180 days
Sale of relinquished property Last day to identify replacement property Last day to close on replacement property

Note: These time restrictions are strictly construed.

How do I identify property?

The replacement property must be identified in writing and delivered to the qualified intermediary by the end of the 45th day. The replacement property must be identified with specificity, either by address, tax map and parcel number, unit number, etc. You may identify more than one property as replacement, but you must comply with one of three rules.

  1. You may identify up to three properties with any value to replace your relinquished property.
  2. You may identify more than three properties as possible replacements for your property as long as the aggregate value of those replacements does not exceed 200% of the value of your property. For example, if you have an apartment building for sale, and its value is $200,000, you can identify any number (over 3) of replacement properties with a combined value of $400,000, regardless of any debt you may have on the apartment building.
  3. You may identify any number of properties as long as you end up purchasing at least 95% of the aggregate value of all properties identified. Note:This is a very unusual method.

Ask your qualified intermediary for a sample identification letter.

Can I buy replacement property first?

This situation is called a reverse exchange. If at all possible, it is better for you to sell your relinquished property first, before acquiring the replacement property. Sometimes, however, this is just not possible, and the replacement property must be acquired immediately to avoid losing the deal.

How does a reverse exchange work?

When you purchase your replacement property before you sell your initial property, this is known as a reverse exchange. Although not the preferred exchange structure, this situation can be accommodated through the following steps.

Your agent will set up a limited liability company, called the Exchange Accommodation Titleholder or EAT to acquire your replacement property and hold it until you sell your relinquished property.

A Qualified Exchange Accommodation Agreement and all other documents are prepared by your qualified intermediary. The EAT must borrow the funds necessary to purchase the replacement property, and you must guarantee this loan, or actually lend the funds yourself.

When you sell your relinquished property, those proceeds are used to buy the replacement property from the EAT and pay off the loan. The EAT then transfers ownership of the limited liability company to you.

You have 45 days after the transfer of the replacement property to the EAT to identify the property you are going to sell. The same rules of identification mentioned above apply. Within 180 days after the transfer of the replacement property to the EAT, you must close on the sale of your property. In other words, the EAT cannot hold title to the replacement property longer than 180 days.

Are 1031 Exchanges limited to real estate?

No, 1031 exchanges can be applied to personal property as well as real estate. The tax code states that as long as the property is being used in a trade or business or held for investment, it may be exchanged for property of like kind. “Like-kind” has a broad definition as applied to real estate, but takes on a literal meaning when referring to personal property.

For example, replacing a heavy-duty truck with a light-duty truck is not considered a like-kind exchange. Replacement property must be “like-kind” and in the same General Asset Class or Product Class, as listed within Division D of the North American Industry Classification System.

If you are considering an exchange of personal property, talk with your accountant first to determine if the items fall into the same asset class

What happens if I change my mind?

After the sale of your relinquished property and the deposit of the proceeds with the qualified intermediary (QI), if you are unable or unwilling to identify a replacement property, the proceeds, less the fee of the QI, will be returned to you with all accrued interest on the 46th day.

If you do identify replacement property, but do not close on it within 180 days, the proceeds, less the fee of the QI, will be returned to you on the 181st day with all accrued interest.

If you change your mind about closing on your replacement property and you want your proceeds returned, this would be an early disbursement, and contrary to the exchange agreement.

In any event, if you do not close on replacement property, the proceeds from the sale of your property will be taxed at the prevailing capital gains rate.

What is an exchange agreement?

An exchange agreement is the contract between the qualified intermediary and you. It sets out the duties and obligations of both parties, and also sets out the conditions under which your proceeds can be released to you.

What is a cooperation clause?

When you contract to sell your property, you make the buyer aware, by special language in the contract, of your intention to do a 1031 Exchange. This will not delay the closing nor will it cause the buyer any additional expense. A similar clause must be inserted in the contract for your replacement property to advise the seller of your intention to do a 1031 Exchange.

The content of this website is informational only. It does not constitute tax, legal or accounting advice. Each situation is different, and you are advised to seek appropriate professional advice to learn if a 1031 Tax Deferred Exchange meets your needs.

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  • Fayetteville, NC 28303
Office:
910-483-5555
800-222-2965
Fax:
800-633-1618
Email:
BridgeTrust Title Group - Fayetteville
 

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Services offered vary by state. In certain states, including North Carolina and South Carolina, BridgeTrust Title Group and its Affiliates do not offer title search/examination and certain closing services to non-attorney customers and, in those states, such activities are performed only under the supervision of an attorney duly licensed in that state. [Any inquiry for such services will be treated as a request for a referral to an attorney in that state.]

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