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​​The TIME Team

You have just negotiated a sale of your business or investment property. You want to defer capital gain taxes by entering into a Section 1031 tax-deferred exchange. How should you proceed?

Steps

1. Consult with your CPA, financial planner, attorney or other adviser to determine if you would benefit from a Section 1031 tax-deferred exchange.

2. Instruct your real estate agent or attorney to insert a clause into the Purchase and Sale Contract requiring the buyer to cooperate with the exchange process.

3. Inform your escrow officer or closing professional that you will be engaging in a 1031 tax-deferred exchange.

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 4. Contact a Qualified Intermediary, also known as an Accommodator or Facilitator to open your exchange. Provide the QI with the following information: Your name, address, telephone and fax numbers, e-mail address and taxpayer’s tax identification number; Sales price of the property; Amount of third-party debt or seller carry-back financing; Escrow or closing agent’s or attorney’s name, telephone and fax numbers, e-mail address and file number; Copy of the Purchase and Sale Contract; Copy of the Preliminary Title Report or Commitment for Title Insurance; Copy of the Escrow Instructions (if available).

5. Execute an Exchange Agreement with the Qualified Intermediary.

6. Execute an Assignment, Acceptance and Notice Agreement transferring your rights under the Purchase and Sale Contract and the Escrow Instructions to the Qualified Intermediary and notifying all parties to the transaction of the assignment.

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7. Inform the Qualified Intermediary of the progress of your transaction. At the closing, your escrow or closing agent will disburse any net equity from the relinquished property to your exchange funds account and transfer the title directly to the buyer. The QI should notify you in writing when the QI receives your exchange proceeds. The QI will deposit your funds in a segregated exchange account. Your exchange funds should be invested in a secure, liquid investment vehicle where your principal will not fluctuate and you will earn a competitive interest rate. You will receive monthly statements on this account.

8. Identifying Potential Replacement Property

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9. Mail, fax or hand deliver a signed description of your identified properties to the Qualified Intermediary within 45 calendar days after the transfer of the title of your relinquished property. When identifying your replacement property, you must comply with one of two identification rules.

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10. 3-Property Identification Rule: You may identify up to 3 potential replacement properties without regard to value. Or 200%-Property Identification Rule: You may identify more than 3 potential replacement properties as long as the total fair market value of your identified properties does not exceed 200% of the fair market value of your relinquished property. If the fair market value of your identified properties exceeds the 200% rule, then you must purchase 95% of the aggregate fair market value of your identified properties (excluding any revoked identified properties).

11. You may revoke a property identification at any time during the 45-calendar-day period and identify new potential replacement properties. New identifications and revocations must be in writing. Any property that is acquired during the 45-calendar-day period is considered to have been identified.

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12.  Acquiring Your Replacement Property: Select and close on one or more of your identified replacement properties on or before the earlier of the following dates: a) 180 calendar days after the transfer of the title of your first relinquished property; or b) the due date of the tax return (including filing extensions) for the year in which your relinquished property closes.

13. Defer all capital gain on your transaction by purchasing property that is equal to or greater in value than your relinquished property; reinvest all of the net equity from your relinquished property in the replacement property; and acquire debt on the replacement property that is equal to or greater than the debt on your relinquished property. You may also complete a partial exchange. You will incur tax liability on the non-qualifying portion.

14. Instruct your real estate agent or attorney to insert a clause into the Purchase and Sale Contract, requiring the seller to cooperate with the exchange.

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15. Contact your escrow or other closing professional to arrange for the closing of your replacement property.

16. Inform your exchange administrator at the Qualified Intermediary that you are closing on your replacement property. Provide the QI with your closing information.

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17. Execute an Assignment, Acceptance and Notice Agreement transferring your rights under the Purchase and Sale Contract and the Escrow Instructions to QI and notifying all parties to the transaction of the assignment.

18. Keep in close contact with your exchange administrator at the Qualified Intermediary until the replacement property closes and the funds are wired. The exchange administrator will disburse the net equity from your relinquished property to the escrow or closing agent’s account. The escrow or closing agent will disburse funds to the seller, who will transfer the title directly to you, the buyer.

19. Receiving Your Exchange Funds: You may have access to your exchange funds when you have met one of the following conditions: (1) You have purchased all of your replacement property and your identification period has elapsed; or (2) You have failed to identify any replacement property
within the 45-calendar-day period; or (3) Your 180-calendar-day exchange period has expired; or (4) A material and substantial contingency has occurred after the end of the identification period that: 1) relates to the exchange; 2) is provided for in writing; 3) is beyond the control of you or a disqualified person. The Internal Revenue Service requires the QI to strictly adhere to the above criteria.

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Tips
       
The 45 calendar day identification period goes very, very quickly. Once you know that you are going to be completing a tax-deferred exchange, you should begin working with your real estate broker/agent or your tenant-in-common securities representative in order to identify potential replacement property as quickly as possible. It is much safer if you can have the replacement property under contract and close to closing as close to the closing on your sale transaction as possible.
     
In the cases of real estate property or properties that you are exchanging into must be of equal or greater value than your original property. You are permitted to use a boot which can also mean that you can incorporate personal property such as a car or other qualified assets into the exchange.

Warnings

Tax-deferred exchanges are complex legal and tax structures.Always consult your legal, tax and financial advisers before completing a tax-deferred exchange transaction.