A forward 1031 exchange completes the close on the relinquished property before acquiring the replacement property. This method and a simultaneous 1031 exchange, where both properties are closed at the same time, are the two most common 1031 exchange methods (the third is a reverse 1031 exchange). A forward 1031 exchange is also sometimes called a “Like-Kind Exchange,” “Starker Exchange,” or “Delayed Exchange.”
All the 1031 exchange deadlines and rules still apply with a forward 1031 exchange. A qualified intermediary (QI) has the same role in a forward 1031 exchange as in other 1031 exchanges. As with the other 1031 exchanges, a forward 1031 includes the same great tax deferral benefits.
Executing A Forward 1031 Exchange
There are several steps involved with a forward 1031 exchange, which we’ll go through below.
- To begin the process, you’ll first contact the company that will be doing the 1031 exchange. The first document you’ll sign is an engagement letter with the 1031 exchange company. A W-9 will also be needed to open an escrow account (used by the QI for holding sale proceeds and purchasing the replacement property).
- The relinquished property sale is completed (closed). Your QI should have the necessary paperwork available for the relinquished property and any paperwork related to the initiation of a 1031 exchange. The latter involves 1031 exchange assignment language. This language will also notify all parties involved in the 1031 exchange.
- Next comes the signing of the relinquished property closing and 1031 exchange documents. The buyer will also sign the Notice of Assignment document. Again, your QI should ensure all the right documents are being signed.
- Proceeds from the sale of the relinquished property are wired into the escrow account.
- With proceeds wired, the 45-day replacement property identification period begins. Closing on the replacement property must be done by the 180th day. If a replacement property is not identified by the 45th-day, the 1031 exchange is voided, and funds are returned to the taxpayer. Proceeds from the sale of the relinquished property are taxable at this point.
- The taxpayer signs the Real Estate Purchase Agreement. The QI handles additional 1031 exchange paperwork, such as including the identified property.
- Closing documents are signed, including any specific to the 1031 exchange.
Following 1031 Exchange Deadlines
One of the most important components to ensuring a 1031 exchange executes successfully is to follow its deadlines. These are the 45-day and 180-day deadlines.
The 45-day rule is the identification period. After closing on the sale of the relinquished property, the taxpayer has 45 days to identify up to three properties, which can exceed the sale price of the relinquished property. More than three properties can be identified as long as their total value does not exceed 200% of the relinquished property’s sale price. Once identification is completed, the QI handles 1031 exchange paperwork related to the identification(s).
If the taxpayer is not able to identify a replacement property by midnight on the 45th day, funds will be returned from escrow to the taxpayer the next day. At that point, the 1031 exchange ends, and the sale proceeds from the relinquished property become a taxable event. Federal and state taxes must be paid along with depreciation recapture.
When closing on the replacement property, there’s no reason to wait. But at least, there should be a few days gap between the closing of the relinquished property and the closing of the replacement property. As a general guide, funds from the relinquished property should be in escrow before starting the closing of the replacement property. Your QI should also be aware of these timelines.
Throughout the process, the QI will hold funds in escrow, so they do not come in contact with the taxpayer. Property buy/sell transactions in a 1031 exchange also do not go directly from seller to buyer. They first go to the QI and then to the final party (buyer or seller). At the closing of the replacement property, the seller signs a Notice of Assignment.
As you can see, there are a lot of rules and steps to follow in a 1031 exchange. It doesn’t matter if the exchange is a forward, reverse, or simultaneous exchange. Adherence to deadlines is critical to the success of a 1031 exchange. Using a knowledgeable and experienced QI will help to ensure that your 1031 exchange goes smoothly.