1031 Tax Deferred Exchange Rules
As required by federal law (Treasury Circular 230): “This written communication was not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties that may be imposed under federal tax law”.
Any and all tax issues involving a potential transaction must be reviewed by your tax counsel before entering into a transaction that would create a tax consequence.
Pacwest Real Estate Investments, LLC assumes no liability from those who either use or misuse the following information, which is herein offered for educational purposes only.
The rules of a 1031 tax deferred exchange are fairly simple:
- Sell your property that qualifies for a tax deferred exchange.
Not all properties qualify for a tax deferred exchange. Make very sure that your property does qualify for a tax deferred exchange before you sell. Once sold, it is too late to reverse the tax consequence.
Certain ownership entities can corrupt your opportunity to utilize a tax deferred exchange. Make sure that your tax counsel has approved of the use of a tax deferred exchange.
- Just before closing your sale, you will enter into an Exchange Agreement with an Exchange Accommodator / Exchange Facilitator/ Qualified Intermediary (all the same person, but known by varying names).
- The Exchange Agreement assigns the pending sale to the Exchange Facilitator, who will complete the sale transaction and will hold the net sale proceeds of your sale after closing.
- The Exchange Facilitator will then use those sale proceeds to buy the property or properties that you have placed under contract to complete your tax deferred exchange.
- Acquire a Replacement Property that also qualifies for a tax deferred exchange.
There is an extremely limited period of time between the sale of your property and the purchase of your Replacement Property. If you do not close in time, or if you violate the tax deferred exchange rules, then you pay the gains tax just as if you sold the property.
Specific Detailed Rules
Identify a limited number of potentially acceptable Replacement Properties within 45 days from the date your sale closes.
Option One: Identify as many as three (3) properties of any value.
Option Two: Identify any number of properties, but their composite value can not exceed twice the price of the property that you sold.
You have until the 45th calendar day to identify which option you wish to use, and to create an Identification Letter. All properties must be located within the US and its possessions.
Close the purchase of the Replacement Property within 180 days of the date of your Relinquished Property sale, and prior to filing the tax return for the year in which the sale occurred.
Rules of Safe Exchanging
Words of wisdom from a Real Estate Investment Broker who has been brokering tax deferred exchanges for 39 + years …
- Plan the exchange carefully.
- Understand what you have to sell. What benefits does your property offer to others, and what are those benefits worth if properly marketed?
- Identify about how long it will take to find a qualified buyer for your property.
- Understand the “all cash” price that it will most probably command (you can not carry back financing and expect to successfully create a fully tax deferred exchange).
- Identify what the buyer’s professional inspectors will probably find as they do their “due diligence” evaluation of your property. It may be advantagous to have such inspections performed on your property before you offer it on the market, then correct those identified defects prior to marketing the property.
- Order a Preliminary Title Report from the title compaany that you wish to use to close your sale. Know what your title report will show, and clear title problems now.
- Know what type or types of property that you will purchase in the exchange. What investment benefits do you seek in your next ownership holding period? Where will that property best be located to suit your needs? Who will manage it? How much additional money are you willing to place in the exchange if you find that ideal property, but it is a bit more expensive than your exchange can acquire?
2. Professionally market your property to get the highest cash price and best terms.
- This is no time for amateur-night. Accepting a weak offer (good price, but one made by a person not able to perform) can hang you up for several months. Do not allow others to make your property one of several that they offer on, if only with the intent of closing on one of them.
- Screen the market for potentially acceptable properties.
- If possible, corner one before you sell your property.
- Prepare to CLOSE your exchange purchase. Perform your due diligence evaluation in a very timely manner.
3. Close your sale, and then close your exchange purchase during the 45 day Identification Period!
- Extreme danger awaits those who do not have their Replacement Property:
1. placed under contract (fully accepted offer);
2. all due diligence inspections fully completed;
3. all bids received for work to correct defects; and,
4. all necessary financing in place PRIOR TO THE EXPIRATION of the 45 Day Identification Period!
Note: it is extremely dangerous and can be very costly to attempt a tax deferred exchange without the assistance of an experienced real estate exchange broker.
The benefits are huge for successfully completing the tax deferred exchange, but the costs are extreme for failing in that effort.
Select Bob Nelson, CCIM or one of his brokers of Pacwest Real Estate Investments, LLC as your tax deferred exchange broker. Contact us early in the game; we do our best work when we have time to get it done properly.