Musts for a Successful Exchange

1. Work with a competent tax professional:

1031 exchanges can be complicated, and thus, it is important to discuss your tax goals with a tax professional before entering into an exchange agreement. Your tax advisor can provide you with the advice you need to determine if an exchange is right for the transaction, and can help you structure the exchange so that your tax goals are satisfied. The qualified intermediary cannot provide legal advice about the exchange, nor can they structure the exchange for the taxpayer.

2. Understand the exchange rules:

When performing an exchange, there are many rules that come into play. The taxpayer must abide by these rules for their exchange to qualify for non-recognition treatment under IRC § 1031. Here’s a concise breakdown of the basic rules:

1. Use a Qualified Intermediary: The taxpayer cannot receive or control funds during the exchange period.

2. Exchange Like-Kind Property: The relinquished property and the acquisition property must be like-kind when exchanging.

3. Exchange Equal to or Up: The taxpayer must acquire replacement property that is equal to or greater than the net value of the relinquished property. In addition, the taxpayer must reinvest all net equity from the relinquished property, or a taxable gain will occur.

4. Identify Replacement Property in 45 Days: The replacement property for the exchange must be identified in writing no later than 45 days from the date of sale.

5. Acquire Replacement Property as the Same Taxpayer: When completing an exchange the taxpayer who relinquishes property must be the same taxpayer who acquires property.

6. Acquire Replacement Property within 180 Days Or Before Filing Your Tax Return: The taxpayer has 180 days from the date of sale or the due date of their tax return (for the year of the sale) to complete their exchange. Some taxpayers may choose to file a tax extension to extend their tax filing due date, so that they have the full 180 day period to complete their exchange transaction.

3. Ask Questions:

As an exchange coordinator for a qualified intermediary (QI), I am amazed at the hesitance demonstrated by some taxpayers to ask questions. Taxpayers may make assumptions about exchanging, or “have heard from a friend” what is involved in the completion a successful exchange. However, the reliance upon assumptions and hearsay can be disastrous for the taxpayer!

So what’s the remedy? Find a qualified team of professionals to help you distinguish the facts from the misguided myths! This team may consist of a tax professional (a CPA and/or tax attorney), a real estate broker, and the qualified intermediary. Rely on these parties to answer your questions.

Looking for a good qualified intermediary? Understand that the qualified intermediary plays a very important role in the exchange process. Throughout the exchange, the QI should be available to answer questions and provide guidance to the taxpayer in a timely fashion. In addition, they should remind the taxpayer of their exchange deadlines. A local QI can be available to meet with the taxpayer to accept identification letters in-person, and may offer office hours to consult with those involved in the exchange transaction.

When searching for a QI, ask your tax professionals and brokers for a recommendation. Before you select a QI, ask the staff working for the QI about their experience and education, and verify that the QI maintains both fidelity and errors and omission bonds. In addition, since this QI is holding your funds in their account, be sure to do some research about how funds are held by the QI during the exchange period! A good QI should have no problems providing this information to the taxpayer that is interviewing them for accommodation services!