In a tax deferred (aka 1031 exchange or like-kind) exchange, the property being sold or disposed of is referred to as the relinquished property. The relinquished property is on the opposite side of a 1031 exchange to the replacement property.
In a basic 1031 exchange, there are two properties involved, the relinquished and the replacement property. There are a number of rules to follow to ensure that a 1031 exchange is executed successfully. A common method of exchanging the two properties is to do it simultaneously. In other words, once the relinquished property is sold, the proceeds go directly into the replacement property.
Once the 1031 exchange is completed, the property owner is clear of the relinquished. In the simultaneous exchange, they are effectively the owner of the replacement property once the relinquished property is sold. Of course, the property owner also reaps the tax deferral benefits of a 1031 exchange.
In some cases, the property owner may exchange into more than one property. The 1031 exchange rules offer this kind of flexibility. A qualified intermediary (QI) must perform the 1031 exchange. The QI is familiar with 1031 exchange rules, which takes some of the burden off of the homeowner.
The replacement property must be a like-kind property for the 1031 exchange to be valid. The IRS allows a lot of latitude on what exactly constitutes a like-kind property.
Going back to the rules of a 1031, there are timeframe rules that must be followed. The property owner has six months to close on the replacement property. In more complex real estate transactions, such as commercial property, the deadline might be exceeded. If that happens, the 1031 exchange is invalidated. This can lead to a taxable event.
In some cases, the property owner may not be able to find a viable replacement property. For those cases, exchanging the relinquished property into a DST can be a practical choice. A DST may contain several commercial properties, making the like-kind exchange easier than trying to find a property in the wild.