1031 Tax Deferred Exchanges

The following briefly outlines how a 1031 tax-deferred exchange works:

Section 1031 of the tax code requires that a Qualified Intermediary hold the money from the sale of your property, and that the Qualified Intermediary "sell" and "buy" the properties for you.

Therefore:

1. You assign your right to receive money from the sale of your property to a Qualified Intermediary.

2. The Qualified Intermediary signs the settlement statement acknowledging receipt of the funds and receives the money from the closing agent.

3. The Qualified Intermediary banks the money in a separate money market account so that your money is completely segregated, and always available for immediate purchase of replacement property. You should receive a monthly statement from that bank to prove your Qualified Intermediary is not commingling the funds. This is well misunderstood problem.  If your Qualified Intermediary is retaining any portion of the growth proceeds and they write a check from your exchange account to their general account for their portion of the growth proceeds, they are commingling the funds and putting them therefore at risk.

4. You locate and identify in writing all replacement property(ies) within 45 days after you transfer the relinquished property. This is your obligation. Identification must be in writing, signed and dated by you and sent to your Qualified Intermediary prior to the expiration of the 45-day time limit. During the first 45 days you may change your identification as many times as necessary. Upon the expiration of the 45th day you may only complete the exchange by purchasing a property identified during the 45 days. Do not identify more than three potential replacement properties without consulting with a tax advisor.

5. You contract for the purchase of replacement property(ies). You assign your rights to purchase the replacement property to your Qualified Intermediary.

6. You have the title commitment and contract for your replacement property(ies) sent to your Qualified Intermediary.

7. The Qualified Intermediary forwards your exchange funds to the closing of your replacement property(ies).

8. Your Qualified Intermediary sign the settlement statement acknowledging transmittal of money for the purchase.

9. You "close" on the replacement property(ies) within 180 days after you transfer the relinquished property. 

Important to note:

a) REMEMBER, as a simplified "rule of thumb," you must trade equal or up in fair market value, and equal or up in equity, in order to have a fully tax deferred exchange. Keep this "rule of thumb" in mind when selecting your replacement property.

b) The title to both the relinquished and replacement properties must be held by the exact same entity.

c) If the exchange fails because of failure to comply with the above procedure, or for any reason, your proceeds are refunded to you, and you are taxed as if the exchange never occurred.

d) Section 1031 authorizes direct deeding of the relinquished property by you to the buyer and direct deeding of the replacement property to you from the seller

e) The IRS does not consider construction or improvement to real property that you already own as "like kind" property. Neither does the IRS consider payment of a mortgage on real property that you already own as "like kind."

f) Replacement property may NOT be purchased from a related party (as defined by the IRS).