On the surface, the 26 U.S. (IRC) Code § 1031 is pretty basic. Operating under the title of “Exchange of Real Property Held for Productive Use or Investment,” the 1031 exchange allows you to exchange currently held real property into designated replacement property, or properties. A successful like-kind exchange means you can defer capital gains taxes.
In reality, the 1031 exchange can be a difficult process, complete with rigid deadlines, many moving parts, and the involvement of multiple entities. This can especially be true of the delayed 1031 exchange. By its very nature, this process brings several parties into the mix. Keeping track of who—and what—is involved with the process is necessary to ensure a completed, and successful, 1031 exchange.
Defining the Delayed 1031 Exchange
Let’s first define the delayed 1031 exchange. Through a delayed exchange, you sell your original asset (known as the relinquished property), direct the proceeds to your Qualified Intermediary (QI), then target a replacement property (or properties). The QI then directs proceeds from the sale of your relinquished asset into the purchase of your replacement real estate.
As a reminder, you have 45 days from the time you relinquish your property to identify the replacement asset. And, you have 180 days from the time you sell your property to close on the new one.
The delayed 1031 exchange is used most often, as opposed to the reverse, simultaneous or improvement exchanges. Even with frequency of use, the delayed exchange can be very complex, mainly because of the many entities involved.
Who Is Involved?
With an understanding of the delayed 1031 exchange basics, it’s time to discuss who is involved with the process.
The exchanger is a fancy name for the individual taxpayer or entity that owns the relinquished property, and is interested in exchanging it into another one. If you are the exchanger, you’re the one who launches the like-kind exchange process.
Relinquished Property Buyer
This is the individual or entity who acquires your relinquished asset. Once that sale is closed, however, you don’t take ownership of the proceeds. Rather, those proceeds are directed to your QI, who keeps it safe until you’re ready to close on your replacement property or properties.
Replacement Property Seller(s)
The replacement property seller is the entity from which you’ll buy the replacement property. However, the “seller” could actually be “sellers,” as you have three options when it comes to the replacement property: The three-property rule, the 200% rule, or the 95% rule. Depending on which rule you follow, you could be dealing with multiple property sellers.
The other consideration? The replacement property seller (or sellers) will likely not be the same as the individual or entity that acquired your relinquished property. This could lead to multiple contracts, different closing timelines and the necessity of keeping track of many moving parts during the exchange process.
Finally, whether your exchange is delayed, reversed, or simultaneous, use of a Qualified Intermediary is an absolute must. The QI facilitates proceed transfers, while preparing and facilitating the necessary paperwork to ensure a successful exchange. In the eyes of the IRS, a 1031 exchange without a QI is no exchange. This means no deferred taxes.
The Importance of Keeping Track
On paper, the delayed 1031 exchange is pretty straightforward. Sell your property, find a replacement one, and get everything settled. But the make-up of the like-kind exchange means the involvement of multiple parties and entities. As such, a successful like-kind exchange means keeping track of those who are participating in it.