6 Steps to Completing a 1031 Exchange
There are some key deadlines you need to meet in order to successfully complete a 1031 exchange. While this section provides a walkthrough of the exchange process, it’s always a good idea to consult with experienced tax and legal professionals prior to beginning an exchange to ensure you meet your investing expectations, IRS deadlines and avoid potential pitfalls.
Step 1: Plan ahead
Due to the deadlines involved with 1031 exchanges, it’s important that investors strategize prior to relinquishing an investing property. Start by thinking about the types of replacement assets that best meet your investment goals while meeting the “like-kind” definition required by the IRS. Many regions of the U.S. have red-hot real estate markets, so it could be even more difficult to find like-kind assets in these areas. Getting the pieces in play before selling (relinquishing) is crucial to ensuring a successful exchange.
Step 2: Assemble an exchange deal team
It’s likely you already have an accountancy and tax professional in place. You’ll also need to engage a third-party Qualified Intermediary (QI) to complete a 1031 exchange since investors aren’t allowed to handle any proceeds from the sale of their relinquished assets.
QIs, also called Exchange Accommodators, fulfill several important duties. They acquire relinquished properties from exchangers and transfer title to buyers. They also acquire replacement assets from sellers and transfer title to exchangers. In between, they’ll handle all the documentation required to complete the exchange.
Since Qualified Intermediaries also hold all proceeds from the sale of relinquished assets in escrow until they are needed to purchase like-kind replacements -- it’s important to choose a carefully vetted QI to avoid the potential for malfeasance.
Step 3: Identify replacement properties
Replacement properties must be similar in character or investment-grade as the asset you are selling. Exchangers have 45 calendar days to identify up to three replacements assets after the close of sale on their relinquished properties. You can identify more than three properties if the cumulative value doesn’t exceed 200 percent of your relinquished asset’s sale price.
Step 4. Line up acquisition financing
When paying off the debt on your relinquished property, you typically want to replace it with a similar debt load for the replacement asset. Make sure you have the ability to secure financing or capital equity to complete the exchange on time. Since you only have 180 days to complete the exchange after selling your relinquished property, it’s important to make sure this piece of the puzzle fits before beginning the exchange process.
Step 5: Sign a contract and let your QI get to work
Once you get a replacement asset under contract and in escrow, your QI begins the legwork of completing the paperwork needed to satisfy exchange requirements.
Step 6. Close on the replacement asset
Once the deal closes, the QI wires funds to the title company, just like any straightforward real estate transaction. To reiterate, you must close on your replacement asset within 180 days after the close of sale on your relinquished property.