The essential rules of the road that experienced exchangers always follow.
The tax deferred exchange of your property completed pursuant to IRC Section 1031 doesn't have to be difficult. But when dealing with multiple properties and their transactional logistics, understanding the process and having access to a trusted expert is the best strategy for a painless, successful exchange. Here are the key "rules of the road" experienced exchangers always follow.
The IRS requires that the property you sell and the property you buy must be like-kind. Like-kind means one of two things: property held for investment, or property held for income — and definitely not your personal residence.
The IRS requires that your exchange be completed with the assistance of a Qualified Intermediary. This should be a well-established firm like Institutional 1031, so you know your exchange documentation will be correct and your exchange funds will be safe between the time you buy and the time you sell.
You must complete your sale and purchase within a total of 180 days, or whenever your tax return is due. The tax return qualifier means that if you start your exchange late in the year, you might have to file for an extension to receive your full 180 days.
While you have 180 days to complete your exchange, the IRS requires you to identify candidate or target replacement properties within the first 45 days. Usually this identification is made to your Qualified Intermediary by completing a form kept in your exchange file.
While most exchanges are deferred exchanges, others may better suit your situation. If you must buy before you sell, consider a reverse exchange. If your replacement property needs improvement or construction, consider an improvement exchange. And if your construction exchange must exceed the 180-day Safe Harbor timing, inquire about a Non-Safe Harbor exchange.
First, buy replacement property equal to or greater than the net selling price of what you sold. Second, move all your equity from the old property into the new property. Third, replace your debt.
First, make sure your exchange funds are safe — the industry is largely unregulated, so insist on a well-established QI and a Qualified Escrow Account. Bonding and deposit insurance don't provide the same protection. Second, start looking for replacement property as soon as possible; the 45-day identification period moves very quickly.
It is always better to buy and vest your replacement property in the same name and entity in which you sold. Changing entities mid-exchange could cause your exchange to fail for lack of meeting the held-for-investment or held-for-income requirement of IRC Section 1031.
If you are still within your 45-day identification period, you can revoke a previous identification and re-identify new replacement property. Simply complete your new identification and add revocation language at the top of your form.
If you need access to tax-free cash, borrow against your relinquished property well in advance of your exchange, or against your new replacement property after you've closed it. Borrowing too close to the start of your exchange could create an argument that it was part of a stepped transaction and therefore not eligible for deferred gain treatment.
In active markets where replacement property is difficult to locate, consider identifying an institutional Delaware Statutory Trust (DST) investment as a backup strategy. These are larger, professionally managed, investment-grade portfolios available to accredited investors through Broker-Dealers. Contact us and we can give you names of Broker-Dealers who can answer your DST questions.
We'll guide you through every key, every step of the way.