Investors Must Carefully Use the 1031 Income Tax-Deferred Exchange Process
Section 1031(a)(1) of the Internal Revenue Code generally provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of like kind to be held either for productive use in a trade or business or for investment. Thus, for a transaction to qualify as an exchange under section 1031, the transaction must constitute an exchange, the property relinquished and the property received in the exchange must be held for use in a trade or business or for investment, and the exchanged properties must be of like kind.
In order to successfully complete an 1031 income tax-deferred exchange, investors must follow the following basic steps:
1. Set up an Exchange Account for planned 1031 exchange – This 1031 exchange account should be set up with an experienced and reputable exchanger and must be opened before close of escrow on the property being sold.
This 1031 exchange intermediary must get a copy of the purchase and sale contract and the contact information for the escrow officer handling the closing.
2. Review and Execute the Exchange Agreement with the intermediary exchange company – which will prepare “Phase 1” exchange documents. At the close of escrow, the exchange company would coordinate with the escrow company to obtain all of the necessary signatures from both the buyer and seller on all “Phase 1” exchange documentation.
3. Locate the Replacement Property
Perhaps the most challenging aspect of the 1031 exchange will be finding and identifying the correct replacement property within the required time frame. The IRS requires that potential replacement property is identified on or before day 45 of the exchange and that it (replacement property) must be acquired on or before day 180 of the exchange.
4. Submit 45 Day Identification Letter.
The Identification Letter must be submitted no later than day 45 of the exchange, and all potential replacement properties must be identified in writing in an unambiguous manner.
5. Submit Replacement Property Contract and Escrow Information after a replacement property is under contract and escrow opened.
The intermediary Exchange Company must be provided with a copy of the purchase contract and escrow officer contact information, and it will then prepare the “Phase 2” exchange documents.
6. Request Funds for Deposits Money – This is for deposits on replacement property that can be disbursed from the exchange account per the terms of the purchase contract. In the alternative, deposits can come from the clients personal funds and then reimbursed to the client at the closing of escrow on the property.
7. Execute Phase 2 Exchange Documents at the close of escrow on purchase of the replacement property. The intermediary exchange company will work with the new escrow company to obtain all needed signatures for exchange documentation.
There might be other steps depending on the complexity of the property exchange situation.
Source of information is Asset Exchange Company, Orange County, CA. This is for information only and is not the providing of legal or tax services. For your own investor situation and possible 1031 exchange, you should consult with an experienced real estate attorney, a certified public accountant and the Internal Revenue Service.
By Harrison K. Long – Professional real estate representative and Realtor, Coldwell Banker Previews, Orange County, CA – CA BRE 01410855