Structuring Your Real Property 1031 Exchange
Sometimes it’s obvious which type of 1031 exchange to use. Often, property transactions are complex and it’s not immediately obvious how or if your property qualifies for a 1031 exchange. An individual or entity selling one property and buying another is referred to as the “exchanger.” Read each definition, then talk to us about which structure best meets your needs.
SIMULTANEOUS EXCHANGE – Your real property is sold (relinquished) and different real property is purchased (replacement) at the exact same time and at the same escrow office. This is the original type of 1031 exchange but it is seldom used today. The simultaneous exchange can be logistically difficult, especially with a complex transaction involving properties in different cities or states. Also, the title name selling should match the title name buying.
DELAYED EXCHANGE – Real property is sold (relinquished) and another real property is purchased (replacement) within 180 days. Replacement property must be identified within 45 days. This is the most popular type of 1031 exchange.
Click to see 10 Steps to a Successful 1031 Exchange
IMPROVEMENT EXCHANGE – Also known as a “construction” or “build-to-suit” exchange. For a completely tax deferred transaction, the exchanger must trade “across” or “up” in equity and debt. If the exchanger goes down in value when acquiring the replacement property he/she will have a tax liability on the cash or mortgage boot.
Improvements to the property by the exchanger can defer the tax liability, if:
Be aware that not all qualified intermediaries (QI) specialize in improvement exchanges.
REVERSE EXCHANGE – The replacement property is purchased before the initial property is sold. This is an option when the exchanger must close on the replacement property before a buyer has been found for the relinquished property.
Special care must be taken with reverse exchanges.
Reverse exchanges can be complex and expensive. Ask us to refer you to a qualified intermediary (QI) with extensive experience in these types of exchanges.
When You Cannot Use a 1031 Exchange
A few situations do not qualify for a 1031 exchange, such as:
Step 1. Retain counsel. Financial professionals, attorneys, accountants, CPAs and enrolled agents can be most helpful when they are included in the process as early as possible.
Step 2. Choose a commercial real estate agent to sell commercial property. List the property. Include a Cooperation Clause in the sales agreement. You may copy and paste this: “Buyer is aware that the seller’s intention is to complete a 1031 Exchange through this transaction and hereby agrees to cooperate with the seller to accomplish a 1031 Exchange, at no additional cost or liability to the buyer.”
Step 3. Choose a Qualified Intermediary (QI). Contact the QI and inform him or her of the intention to sell property and conduct an exchange. Enter into a 1031 Exchange Agreement with the QI. The Qualified Intermediary is named as principal in the sale of the relinquished property and the subsequent purchase of the replacement property. The 1031 Exchange Agreement must meet with federal tax law requirements, especially pertaining to the proceeds. Along with the basic agreement document, an amendment to escrow document is signed which names the Qualified Intermediary as seller. Normally the deed is prepared for recording from the taxpayer to the true buyer. This is called direct deeding. It is not yet necessary to have the replacement property identified.
Step 4. Choose a title company and ask the escrow officer/closing agent to contact the Qualified Intermediary to order the exchange documents.
Step 5. Sell the property (referred to as “relinquished”) and search for like-kind property (referred to as “replacement”).
Step 6. When the relinquished escrow closes, the closing statement reflects that the Qualified Intermediary was the seller and the proceeds go to the Qualified Intermediary. The funds should be placed in a separate, completely segregated money market account to insure liquidity and safety. The closing date of the relinquished property escrow is Day One of the exchange and that is when the exchange clock begins to tick. Written identification (i.e., the address) of the replacement property must be sent to the QI within 45 days and the identified replacement property must be acquired by the taxpayer within 180 days.
Step 7. The taxpayer sends written identification of the address or legal description of the replacement property to the Qualified Intermediary on or before Day 45 of the exchange. The document must be signed by everyone who signed the exchange agreement. It may be faxed, hand-delivered, or mailed either to the Qualified Intermediary, the seller of the replacement property, or his agent or to a totally unrelated attorney, preferably by certified mail, return receipt requested.
Step 8. The taxpayer enters into an agreement to purchase replacement property, again including the Cooperation Clause. “Seller is aware that the buyer’s intention is to complete a 1031 exchange through this transaction and hereby agrees to cooperate with buyer to accomplish same, at no additional cost or liability to seller.” An amendment is signed naming the Qualified Intermediary as buyer, but again the deeding is from the true seller to the taxpayer.
Step 9. When conditions are satisfied and escrow is prepared to close, which is certainly prior to the 180th day per the 1031 Exchange Agreement, the Qualified Intermediary forwards the exchange funds and gross proceeds to escrow and the closing statement reflects the Qualified Intermediary as the buyer. A final accounting is sent by the Qualified Intermediary to the taxpayer, showing the funds coming in from one escrow, and going out to the other, all without constructive receipt by the taxpayer. Property title is placed into the name of the exchanger.
Step 10. Taxpayer files form 8824 with the IRS when taxes are filed, and whatever similar state documents are required.
