Under Section 1031 of the Internal Revenue Code, owners of real estate held for investment or use in a trade or business can swap their property tax-free for “like-kind” real estate. Exchanges are made for people desiring to stay invested in real estate, increase their leverage and to avoid paying hefty taxes upon the sale of property.
- Rental Houses
- Retail Properties
- Raw Land
- Office Buildings
- Personal Residences
- Dealer Property
- Partnership Interests
Reason to Exchanges:
- Restoring Depreciation that will soon expire – by exchanging one property for another of greater value.
- To upgrade size and/or quality of investment. An exchange can be utilized to combine the equity of one or more properties into a larger singular investment.
- To change investment location. An exchange can be executed in anticipation of market trends to maximize appreciation potential.
7 Steps for a Successful 1031 Tax Deferred Exchange
- Consult with your tax and financial adviser to determine if a tax-deferred exchange is appropriate for your circumstances and compatible with your investment goals.
- Listing the Relinquished Property for sale with a licensed real estate broker. During the first step the Exchanger will list the Relinquished Property with a real estate broker. The broker/agent will disclose the intent to complete an exchange in the listing agreement.
- Offer, Counter Offer and Acceptance. The Exchanger enters into a contract with the Buyer for the sale/exchange of the Relinquished Property. The broker/agent discloses the Seller/Exchanger’s intent to exchange into the Purchase Agreement and Receipt for Deposit.
- Open escrow for the Relinquished Property and coordinate with the Facilitator. The Facilitator prepares the exchange agreement and coordinates with the escrow holder to close escrow as Phase 1 of a tax deferred exchange. Important: The exchange agreement must be in place and signed by all parties prior to close of escrow. Additionally, all earnest money deposits should be placed with the title company.
- Replacement Property Identification. After closing escrow for the sale of the Relinquished Property, the Exchanger must identify all Replacement Property within 45 days from day after close of escrow.
- Contracting for the Replacement Property. After closing on the Relinquished Property the Exchanger has 180 days to acquire the Replacement Property. With the help of his or her agent the Exchanger enters into contract to purchase the Replacement Property from the Seller. In the contract to purchase the agent discloses the Exchanger’s intent to complete the exchange and obtains the Seller’s cooperation.
- Open Escrow for the Replacement Property. The Facilitator prepares the Phase II Exchange Agreement and coordinates with the Replacement Property Escrow holder. The funds held in trust by the Facilitator are placed in escrow and the Replacement Property is purchased by the Facilitator from the seller. The Facilitator then transfers the Replacement Property to the Exchanger and the transaction is closed as Phase II of a delayed exchange.
Identification of Replacement Property
Regardless of the number of relinquished properties transferred by the Exchanger as part of the same exchange, the maximum number of replacement properties that the Exchanger can identify is as follows:
3 Property Rule: Three properties without regard to the fair market values of the replacement properties.