1031 Step by Step
By following this guide, you'll be well-equipped to navigate the complexities of a 1031 exchange and potentially save significant amounts in taxes. Remember, while this guide provides a solid foundation, it's crucial to consult with qualified tax and legal professionals to ensure your specific situation is properly addressed. Let's begin with the first phase of the exchange: selling your relinquished property.
Steps for Relinquished Property Sold
Consult your tax advisor, legal team, and 1031 Tax-free Exchange Solutions as reasonably far in advance as possible to discuss your transaction. This will help you avoid many undesired “surprises” and maximize your exchange value.
As you are accepting your offer for sale, consider if you need any extra time to locate a suitable replacement property. By doing this, you may, in some cases, ask the buyer for a little extra time to close your sale, giving you more time before your 1031 clocks start. Do not risk losing your buyer to negotiate for this time; however, if possible, you or your agent can approach this with your buyer.
If you have not already begun to search for replacement property, do not delay any further. You may make offers on replacement property BEFORE your property closes.
Once the offer is accepted, notify your buyer you are doing a 1031 Exchange. It could be as simple as typing in the remarks section of the contract “Seller to elect IRC Section 1031 Exchange treatment on this sale at no cost, liability or delay in close to buyer”. You may also use a prescribed notification statement from your attorney or realtor.
Open escrow. Let your escrow officer know you are doing a 1031 Exchange. Let them also know 1031 TES will be the Qualified Intermediary (QI). If a contact person/processor has not already been assigned and given to you, you may give them my name, email address and phone number. Let them know we will be reaching out to them for documents needed for the exchange shortly. WE MUST BE ENGAGED PRIOR TO CLOSE so that the title company is authorized to wire the proceeds to us as you the seller cannot have constructive receipt of the funds at any time during the sale, purchase or exchange,
If you have not already done so, CONTACT 1031 TES at this time with the contact information for your Title/Escrow company and the escrow officer’s name. If an attorney is handling your close, please provide their contact information in kind.
If not already provided we will request certain information about your transaction, answer any last-minute questions and prepare your Exchange Agreement for execution (preferably by DocuSign) as soon as the escrow officer or attorney provides us their documents confirmation Title and a copy of the contact.
Once you contact 1031 TES with this information and you have executed your DocuSign (or signed paper documents), we are now in the queue to receive your proceeds. This allows you to defer the tax from the sale if you are successful in finding a suitable replacement property. We will wait until the property closes to receive the proceeds. We will be in regular contact with your closing agents during this process for multiple verifications to ensure boxes have been checked and all is ready to close.
Replacement Property Purchased:
Your property being sold closes, and funds are wired to BEA 1031 LLC and deposited in a large-cap national bank using your tax ID, name, or other identifying information, such as a Trust or LLC. The receipt of these funds is often NOT the same day of the close, as the wire may have been sent after the wire cut-off time for that day. YOUR 45-day and 180-day Clocks ARE NOW TICKING.
Once we receive the proceeds, we confirm we received the correct amount and then confirm with you via email how much was received, your 45 Calendar Day Identification Deadline, your 180 Calendar Day Deadline, along with a copy of your Identification Statement to be used to officially identify property to us by day 45. Remember, day 45 may land on a weekend or holiday; THESE DAYS COUNT, so, please be conscious of this so you do NOT miss the deadline. Missing the deadline is almost a guaranteed failure of the exchange in most cases.
Continue looking for replacement property. AS SOON AS you have an accepted offer on a replacement property, again contact your exchange processor with the address, close date, Title/Escrow Officer, or Attorney closing the transaction along with any requests for Earnest Money Deposits. Once we have your proceeds, we can make earnest money deposits for you with a 48-hour advance notice.
IF YOU HAVE NOT NOTIFIED US PRIOR TO DAY 45 of any property you are working on or wish to be part of the exchange, you MUST IDENTIFY all property to us you wish eligible NO LATER THAN the close of business on day 45. We do NOT need to be notified prior to day 45 if you do not have anything and you do not need to have made an offer on a property or have it under contact simply to identify it. You are NOT required to purchase a property simply because you identified it. The list of properties identified cannot be changed or modified after day 45 and becomes the only property eligible for purchase with the exchange going forward.
There are three ways to Identify depending on what you are doing with this exchange. Please contact us to discuss the different ways if you have any questions. The three ways are:
3 Property Rule: Up to three properties of ANY value (Typically used if you are buying only one or two assets close to the price you sold. In this case, you can purchase up to three.
200% Rule: Four or more properties however the cumulative value of all property cannot exceed of what was sold. You may buy only one or you can buy all of them. This method us used when you sold a larger asset and buying many lower priced assets.
95% Exception: Identify as many properties as possible over three you want AND the cumulative value identified EXCEEDS 200%. YOU MUST PURCHASE 95% of what is on the list!! (For portfolio sales and certain other Transactions.
Once you have identified and day 45 has passed you may continue closing on any and all identified properties for an additional 135 calendar days for a total of 180 calendar days in all from start to finish.
Reinvest all cash proceeds being held, replace the value of debt paid off on the property sold with new debt or the equivalent in new cash prior to day 180 to achieve “equal or greater value” to what you sold net of qualified expenses for a tax-deferred exchange. Partial exchanges are allowed; you pay tax on only the portion NOT reinvested to the extent of the gain (any amount over the adjusted basis). (1031 TES and its affiliates have solutions to manage, mitigate and eliminate gain from the sale if needed. Please consult with us for more details and to inquire which programs are both suitable and you are qualified to purchase)
Tips and Tricks
Reverse Exchange
A reverse exchange is exactly that, an exchange in REVERSE. These are used when you MUST purchase a replacement property BEFORE your relinquished property can be sold. The Qualified Intermediary can acquire the property for you using your cash and give you up to 180 calendar days to SELL your property being sold.
Improvement Exchange
An improvement exchange is used when you purchase a property of LESSER value than you sold and instead of paying tax on unused proceeds, the Qualified Intermediary can help you make the improvements on the property being purchased before you take title to it and before day 180 thus improving the value adequately to avoid tax on leftover money you were going to spend on the property anyway.
Delaware Statutory Trusts
As an ever-increasingly popular investment suitable for replacement property, investors desire to take a more passive role in real estate investment or perhaps prefer larger, higher quality, professionally managed, and potentially more stable real estate. Ideal for desired changes in lifestyle, estate and family planning, inability to locate suitable replacement property and more.
Opportunity Zones
Not a 1031 Exchange solution, however very useful if you have HIGH BASIS properties and you anticipate not spending all of your proceeds in an exchange. It also works well with ANY form of Realized Gain be it from real estate, stocks, bonds, prepayment of a contract sale early and more.
Other Helpful Strategies
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