Deferred 1031 Exchanges

All the 1031 exchanges that we have discussed so far have had the exchange of property occur simultaneously. However, it is possible, and in fact very common, for a property owner to relinquish his or her property and then subsequently receive a replacement property- even weeks or months later.

Two important requirements must be met in order for a deferred like-kind exchange to qualify for 1031 treatment:

   1) The replacement property must be identified within 45 days after the closing of the sale of the initial (relinquished) property; and

   2) The replacement property must be received within the earlier of 180 days of the closing of the sale of the initial (relinquished) property, or the extended due date of the taxpayer's tax return for the year in which the initial sale occurred.

In order to meet the 45-day identification requirement, you must identify and describe in an unambiguous manner the replacement property in a written document.  The written document must then be delivered to either the person obligated to transfer the replacement property or to any other person involved in the exchange.

As a precaution against identifying a property that is subsequently unable to be delivered to you (and thus not qualifying for Section 1031 treatment), you are allowed to identified more than one replacement property.  In fact, you are allowed to identify up to 3 replacement properties (without regard to their value) or any number of potential replacement properties as long as their aggregate fair market value does not exceed 200% of the aggregate fair market value of the relinquished property.

In order to meet the 180-day receipt requirement, you must actually receive the replacement property within the time period and it must be substantially the same property identified.

A significant potential problem is when people intend to do a deferred 1031 exchange and sell their property, receive the funds, and then use those funds to purchase a replacement property. Unfortunately, that is not a 1031 exchange and will be treated as a sale.

If you or a disqualified person receives, or constructively receives, any cash or non-like-kind property prior to receiving the replacement property it transforms the transaction into a taxable event or partially taxable event depending on the amount received.  If the amount was equal to the full consideration of the relinquished property, then the transaction is treated as a sale.  If the amount received is less than full consideration, then the transaction is treated as a partially taxable exchange.

There are a group of people who are considered disqualified persons because they are viewed as your agent or as related-parties. This group includes your employees, attorney, accountant, banker, and real estate agent/broker.

There are a number of qualifying arrangements that can be made to work around this limitation. One of which is the use a qualified intermediary.  A qualified intermediary is someone who is not a disqualified person and enters into a written agreement with you.  Under that agreement, the qualified intermediary acquires the relinquished property from you and then transfers the relinquished property to a 3rd party.  The qualified intermediary will then acquire the replacement property and transfer it to you.

Here is an example of how a deferred 1031 exchange may look.

You own a rental property in Santee with a fair market value of $550,000, but you would like a rental property closer to your home in Vista. You find a qualified intermediary and enter into an exchange agreement to perform a 1031 exchange. You then find a buyer for your property in Santee. Instead of selling the property directly to the buyer, you transfer the property to the qualified intermediary. The qualified intermediary then sells the property to the buyer.

Within 45 days, you find 3 properties that you may be interested in, and your provide their addresses to the qualified intermediary in a written document. After some negotiations with the sellers, you agree upon a purchase price of $600,000 for one of the properties. The qualified intermediary then goes into escrow with the seller to acquire the property, with you contributing an additional $50,000 cash to make the purchase as well as any exchange fees the qualified intermediary is charging you. After the qualified intermediary acquires the replacement property, it transfers the property to you completing the 1031 exchange.

If you would like to discuss deferred 1031 exchanges further, please send me an e-mail.