1031 Tax Deferred Exchange

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1031 Tax

1031 Tax Deferred Exchange - Section 2 of 7

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Deferring or postponing taxes is an important aspect of investing. The trouble is that deferral normally ends when you sell your real property. Exchanges offer an inviting alternative that permits you to defer taxes even after you sell. Exchanges permit you to reinvest the money that you otherwise would pay in taxes.

You must exchange real property that you hold for investment or for business use for other real property that you will hold for investment or for business use. Property that you hold principally for resale will not qualify for a nontaxable exchange. (Another set of rules apply to selling your principal residence and reinvesting in a new residence. Those rules are not covered by this article.)

For many years, exchanges were limited to true exchanges. You had to transfer your investment property and receive new investment property in exchange on the same day. This resulted in three corner transactions in which the buyer would acquire your replacement property and exchange it to you for your relinquished property.

The trouble with these "simultaneous exchanges" is that closing both ends of the exchange on the same day is difficult. If they failed to close on the same day, you would have to pay tax on your exchange.

This was the state of the law prior to the Starker case in 1979. This case permitted Mr. Starker to transfer his property at one time to an intermediary and for the intermediary later to acquire and to transfer replacement property to Mr. Starker.

It is now possible:

for you to transfer your relinquished property to a qualified intermediary (a party who participates in the transaction to facilitate the exchange) who will sell your relinquished property to your buyer
for you to identify replacement property within 45 days after you transferred your relinquished property,
for your qualified intermediary to acquire the replacement property that you identified, and
for your qualified intermediary to transfer the replacement property to you within 180 days after you transferred your relinquished property.

The tax laws impose several limitations on what we commonly call "nonsimultaneous exchanges" or "deferred exchanges" or "Starker exchanges."

You must:

identify your replacement property within 45 days after you transferred your relinquished property to your qualified intermediary, and
actually acquire your replacement property within 180 days after you transfer your relinquished property to your qualified intermediary.

Tax regulations add a number of additional requirements. The tax regulations tell you:

how to identify replacement property,
how many replacement properties you can identify,
how you can structure an exchange with a qualified intermediary,
how you can "direct deed" your relinquished property to your buyer or have your replacement property "direct deeded" to you,
how you can secure your qualified intermediary's exchange promise,
how you can structure a qualified escrow or a qualified trust,
when you can receive any remaining cash that you do not invest in replacement property,
how can you receive interest on your exchange balance,
and how to handle closing and other transaction costs.

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