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Property Exchanges conforming to IRC section
1031 offer wonderful opportunities to defer tax liability and
maximize profits while helping to continue with the investment of
the capital.
The IRC clearly states the main
qualifying parameter of the exchange as a like-kind exchange. ?In a
like-kind exchange, the property you give up and the property you
receive must be held by you for investment or for productive use in
trade or business Thus 1031 Exchanges can involve only like-kind of
properties.
In all, there are five types of 1031
Exchanges. In Simultaneous Exchange one property is sold and the
next is bought exactly the same time.
In Delayed
Exchange, property is sold and the replacement property is bought
within 180 days. Reverse Exchange has the replacement property
bought before the initial property is sold.
Improvement Exchange uses some of the capital to improve the
property, as in building a road. Personal Property Exchange can also
come under like-kind exchanges other than real estate. That
includes cattle, aircraft, mineral rights, etc.
Just
as there are several types of 1031 Exchanges, the processes in each
of them vary substantially. Delayed Exchange is the most common
type, and also the most popular.
In Delayed Exchange,
the first step is planning out the whole transaction by talking to a
qualified intermediary, otherwise called a facilitator. The
facilitator then ascertains the investment objectives of the seller
or exchanger and suggests the right option after estimating the
amount of potential capital gains and the resultant tax outgo
involved.
Drafting a standard purchase and sale
agreement is the second step, stating the exchanger's intent to
exchange the property and obtaining the buyers consent to cooperate.
The facilitator then suitably converts the sale transaction into an
exchange deal through specialized documentation.
Having
decided to perform an exchange, parties are then notified about the
transaction and the intent to exchange. The parties involved are the
real estate agent, closing agent, accountant and attorney.
The facilitator then collects the information required to prepare
the exchange documents. The originals are then forwarded to the
closing agent for execution during closing. All parties get the
documents for review. After closing, the exchanger will transfer the
relinquished property to the QI, who would then simultaneously sell
the property to the buyer. The proceeds go to the QI and held by him
until the acquisition of the replacement property is over.
In the Delayed Exchange, from the date of closing the relinquished
property the exchanger gets 45 days to identify the replacement
property and 180 days to complete the exchange. The identified
replacement property is purchased by the QI and transferred to the
exchanger in the stipulated time, making the exchange complete.
It is the facilitator, or QI, who answers all questions from the
exchangers accountant or attorney. The exchanger's funds are
deposited in separate and insured accounts to ensure security,
sometimes in a $1,000,000 fidelity bond account.
The
exchange has to be done diligently so that it survives the audit and
scrutiny of the IRS.
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