1031 Exchange

A properly executed 1031 Exchange allows investors to defer gains and accumulate significant wealth by “trading up” during their lifetime without paying capital gains taxes at the time of the sale of each asset. The regulations are strict, however, and the IRS will not permit variations to the “safe harbor” created by the exchange rules.

For more information, visit www.e1031xchange.com

How a 1031 Exchange Works

Step 1: IRC section 1031.

Section 1031 of the Internal Revenue Code permits investors to defer the payment of tax on the gain from the sale of property held for productive use in business, trade or investment, provided that the property is exchanged for a “like kind” asset or assets. The section creates a “safe harbor” that permits the taxpayer to have assurance that the transaction will permit the deferral of the capital gain tax payment.

Step 2: Select a Qualified Intermediary.

The IRS requires that the proceeds from the sale of the property (the “relinquished property”) be held by a qualified intermediary (a “QI”) until the replacement property is purchased. The taxpayer must assign to a QI their interest as seller of relinquished property.

An “exchange agreement” is executed between the taxpayer and 1031 Exchange.

Step 3: Include the exchange cooperation clause as an addendum to contract.

It is important to include language in the contract of sale for both the sale of your relinquished property and the purchase or your replacement property that requires the counterparty to cooperate in the exchange. Typically this is not controversial, as the entire exchange is transparent to your buyer or seller, and there are no delays or costs to them in cooperating.
Here is a sample clause: “Buyer hereby acknowledges that it is the intent of the Seller to effect a Section 1031 tax deferred 1031 Exchange, which will not delay the closing or cause any additional expenses to the Buyer. The Seller’s rights under this agreement may be assigned to 1031 Exchange, a Qualified Intermediary, for the purpose of completing such an exchange. Buyer agrees to cooperate with the Seller and 1031 Exchange to complete the exchange.”
Use the same clause in the purchaser contract, when acquiring a replacement property, just substitute Buyer for Seller, and vice versa.

Step 4: 1031 Exchange signs HUD1 at settlement of the relinquished property, this can be done by facsimile or PDF.
Step 5: Deed is direct from exchange to buyer, 1031 Exchange does not go into the chain of title.
Step 6: 45 days after settlement exchanger must notify 1031 Exchange in writing of potential replacement properties.
Step 7: 180 days to purchase one or more of the replacement properties.

This deadline occurs sooner if tax filing is done before the 180 day expiration. For example, if you sell your relinquished property on December 15, 2011, and submit your tax filing for 2011 on April 1, 2012, then the acquisition of the replacement property must happen on or before April 1, 2012, and not the typical 180 days after sale. To avoid this trap, have your tax preparer file a timely extension.

At closing of replacement property, exchanger assigns the rights in the contract to 1031 Exchange and 1031 Exchange then signs HUD as purchaser. Deed is direct to exchanger, 1031 Exchange never goes into the chain of title.

Step 8: Any remainder is returned but may be taxable as boot.
Step 9: Requirements for deferring the entire taxable gain.

Value of replacement property must be equal to or greater than the value of the relinquished property. Equity in replacement property must be equal to or greater than equity in the relinquished property. Debt on replacement property must be equal to or greater than debt on relinquished property. All of the net proceeds must be used to acquire the replacement property.
No net boot can be received.


For more information, visit www.e1031xchange.com