What is involved in a 1031 Property Exchange?
The benefit of the 1031 Property exchange is to be able to defer tax liability and to maximize profit while continuing with capital investment. 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.
1031 exchanges come in five different types. The five types of 1031 exchange includes the simultaneous exchange, the delayed exchange, reverse exchange, improvement exchange, and personal property exchange. As the name implies, simultaneous exchange is selling and buying that happens at exactly the same time. The delayed exchange is an exchange where the property is sold first and the replacement 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. When capital is used to improved the property, then we call it improvement exchange. Personal property exchange can also comes under like-kind exchanges other than real estate. Cattle, aircraft, mineral rights, etc. are examples of personal property that can fall under personal property exchange.
There are substantial variations in the processes of these different types of exchanges. Among the different types of property exchanges, the most common and popular types is the delayed 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.
Then purchase and sales agreements are drafted stating the intent of the seller or exchanger to exchange the property with the cooperation of the buyer. Then the facilitator converts the sales transaction into an exchange deal through specialized documentation.
There is notification sent to certain parties about the transaction and intent to exchange. The parties notified are the real estate agent, closing agent, accountant, and attorney.
Exchange documents are then prepared by the facilitator by collecting required information. During closing, the closing agent executes the documents forwarded to him by the facilitator. The documents are then reviewed by the different parties involved. So when the closing is fulfilled, the property is transferred to the QI to sell to the buyer simultaneously. Until the replacement property is bought, the proceeds of the sale is handled by the QI.
In delayed exchange, the exchanger has 45 days from the closing date of the relinquished property to find a replacement property and 180 days to complete the exchange. To complete the exchange, the QI will purchase the replacement property identified and transferred to the exchanger in due time.