What is involved in a 1031 Property Exchange?
The 1031 Property Exchange offer wonderful opportunities to defer tax liability and maximize profits while helping to continue with the investment of the capital. The main requirements for the exchange is that it is a like-kind exchange where the property you give up and the property you receive must be held by you for investment or for productive use in trade or business. So only like-kind properties are involved in a 1031 exchange.
There are five types of 1031 exchanges. The simultaneous exchange, the delayed exchange, reverse exchange, improvement exchange, and personal property exchange are the types of 1031 exchange. When a property is sold at the same time another property is bought, then this is the simultaneous exchange. In delayed exchange, property is sold and the replacement property is bought within 180 days. In reverse exchange there is a reversal seen in the way the replacement property is bought first before selling the initial property. Improvement exchange uses some of the capital to improve the property. There can be 1031 exchanges that does not involve real estate but are also like-kind exchanges and these are called personal property exchange. Cattle, aircraft, mineral rights, etc. are examples of personal property that can fall under personal property exchange.
Each of the processes in these different types of exchanges vary substantially. The delayed exchange is the most common and most popular type of 1031 property exchange.
The property owner who is interested in a 1031 exchange talks to a qualified intermediary (QI), or facilitator, in order to plan out the whole transaction. What the facilitator does is to ascertain the objective of the property seller or exchanger and makes suggestions as to the right options once he has estimated the amount of potential capital gains and the tax deferred.
The facilitator then drafts the purchase and sale agreements, stating the intent of the exchanger to exchange the property and getting the cooperation of the buyer. Then specialized documentation is prepared by the facilitator converting the sales transaction into an exchange deal.
Parties are then notified about the transaction and the intent to exchange, having decide to perform an exchange. The parties involved are the real estate agent, closing agent, accountant, and attorney.
By collecting the information required, the facilitator is able to prepare the exchange documents. Then these documents are forwarded to the closing agent for execution during closing. Parties then review the documents. The QI will then sell the property to the buyer after the closing. The proceeds go to the QI and held by him until the acquisition of the replacement property is over.
In delayed exchange, from the date of closing the relinquished property, the exchanger gets 45 days to identify the replacement property and 180 days to complete the exchange. The identified replacement property is purchased by the QI and transferred to the exchanger in the stipulated time, making the exchange complete.