1031 Exchange

1031 Exchange

There are many options to consider when choosing a Qualified Intermediary to facilitate the 1031 exchange, and in regards to professionalism, knowledge and incredible customer service, The Gustavson Group has found none better than Xchange Solutions based out of San Jose, California.

Xchange Solutions is an independent 1031 exchange intermediary service, founded in 1996 by Jonathan Baughman and Kevin Hereford to provide the most professional and complete intermediary service in the industry. Offices are located in San Jose, San Mateo, Santa Cruz, Reno, and Seattle, Washington, however if you are working with The Gustavson Group you will be working directly with Founders Jonathan Baughman and Kevin Hereford here in San Jose.

Xchange Solutions is a member of the Federation of Exchange Accommodators, the largest national professional association providing 1031 education. With over 50 years of combined 1031 exchange experience, and tens of thousands of transactions closed, they truly are the best around.

Call Jonathan directly at 1-800-410-1031 if you have any questions about their services as your Qualified Intermediary.

1031 Exchange FAQ

Steps to Complete a Typical 1031 Exchange

Step 1 - Plan the Transaction: Talk with your exchange facilitator to discuss your transaction. After listening to your investment objectives we'll determine the best way to structure your transaction. We'll estimate the amount of potential capital gains taxes you'll save.

Step 2- Purchase & Sale Agreement: The exchange often begins with a standard purchase and sale agreement. The agreement will contain language which establishes the exchanger's intent to exchange and obtains the buyers consent to cooperate. Your exchange facilitator will convert this "sale" transaction into an exchange with the use of specialized documentation.

Step 3 - Relinquished Property: Once you have decided to perform an exchange contact The Gustavson Group & Xchange Solutions immediately. Also notify all parties to the transaction of your intent to exchange, including your real estate agent, escrow officer, and attorney. We will collect the information needed to prepare the exchange documents. The originals will be forwarded to the closing agent for execution at closing. Copies are sent to all parties for review. At closing the exchanger will transfer the relinquished property to the intermediary who will simultaneously sell the property to the buyer.

Step 4 - Replacement Property: After closing the relinquished property, the exchanger (and you) will have 45 days to identify the replacement property and 180 days to complete the exchange. The exchanger notifies us once they have entered into an agreement to purchase the replacement property. We will deliver the documents needed to complete the exchange to the closing agent. At closing, the property is transferred to the exchanger. The exchange is now complete.

Most Important! - Your exchange facilitator and the team at The Gustavson Group are available at every stage of the process to answer any and all questions from you, your accountant or attorney. We are specialists in these areas, and pride ourselves on always being available to answer the tough questions.

1031 Exchange Frequently Asked Questions

Effectively, Internal Revenue Code Section 1031 exchanges allow investors to sell property and reinvest the proceeds in another property without having to pay taxes that would otherwise be owed on recognized gain from sale. The payment of such capital gains tax is deferred, representing only a potential tax which is not owed unless and until the replacement property is sold in a subsequent taxable transaction. The taxes may, in some cases, be avoided all together, for example if the replacement property passes through an estate and its basis is stepped up to the market value at the time of death.

Section 1031 of the IRC provides that no gain or loss is recognized if property “held for productive use in a trade or business or for investment” is traded solely for other “like-kind” property which also is to be held for investment or used in a trade or business. The essence of such a trade is a reciprocal and interdependent transfer of one property for another, as opposed to a simple sale and repurchase.

While transactions may vary, the basic exchange usually proceeds like this:

  1. The seller (“exchanger”) of the property to be exchanged, (“relinquished property”), finds a buyer to purchase his/her property. The Exchanger includes specific “intent and cooperation” language in the purchase contract: the exchanger expresses intent to exchange and the buyer expresses cooperation in signing any necessary and appropriate documents to accomplish the exchange.
  2. The exchanger and (“intermediary”) enter into an Exchange Agreement and an Assignment and Substitution Agreement which provide that: (a) The intermediary is substituted into the purchase contract (and escrow instructions, if applicable) as the seller. (b) The exchanger conveys the relinquished property to the intermediary, and the intermediary immediately conveys the relinquished property to the buyer by direct deed from the exchanger. (c) The proceeds from the exchange of the relinquished property are held in a Qualified Escrow Account. (d) The exchanger identifies in writing the property they wish to acquire (“replacement property”) in exchange for the relinquished property. (e) The intermediary is substituted into the purchase contract (and escrow instructions, if applicable) as the buyer. (f) The intermediary, using the funds held on account, acquires the replacement property, and immediately conveys the replacement property to the exchanger by direct deed from the seller of the replacement property to the exchanger.
THIS ENTIRE TRANSACTION HAS BEEN PROTECTED AS FOLLOWS:

  1. A guaranty of escrow funds by a national title company.
  2. Letters of credit are issued by the institution holding exchange funds.
  3. Funds are held in a restricted, protected, joint-signature account at a bank.
Simultaneous exchange: you convey the title to the relinquished property concurrent with and just before receiving the replacement property.

Delayed exchange (also called a “Starker” or “deferred” exchange), you convey title to the relinquished property up to 180 days before acquiring title to the replacement property.

Previously the IRS held that qualifying exchanges must be simultaneous. Delayed exchanges were sanctioned by court action in the landmark case Starker v. United States in 1979. In response to Starker, Congress formally approved delayed exchanges by way of the Tax Reform Act of 1984, which added the statutory 45 day identification and 180 day closing time-frames. With the new Final Regulations for Delayed Exchanges issued in June of 1991, exchanges adhering to the safe harbors defined therein are perhaps better able to withstand audit than are simultaneous transactions.

Reverse Exchanges (“Reverse Starker”) the exchanger acquires the replacement property before conveying the relinquished property. These are used when individuals wish to exchange property they own for property which must be purchased prior to the sale of the relinquished property.
“Construction” or improvement exchanges are for replacement property to be built. The replacement property is built-to-suit, or is further improved or altered, etc., to the specifications of the exchanger. In a construction exchange, the intermediary usually acquires the replacement property, causes the improvements to be built during its ownership, and conveys the improved property to the exchanger. The building is done in accordance with the building specifications outlined in the purchase contract, and/or escrow instructions, prior to the substitution of the intermediary as the buyer. The exchanger approves all work done before disbursement of funds by the intermediary and exchangers may use the contractor of their choice as long as they are not a “disqualified” person under the Regulations.

While real property improvements need not be completed within the Exchange Period, the value of any portion of the improvements not completed within this time frame will not qualify as replacement property. The 180-day Exchange Period may effectively be extended by delaying the transfer of the relinquished property. This may allow some time for work to begin on construction of improvement on the replacement property. Property “to be produced” in a construction exchange, which is not completed within the 180-day Exchange Period, must be part of the standing structure to be considered real property under local law. A load of raw building material delivered to the building site, will not qualify as improved real property.

Partially tax-deferred exchanges are transactions in which some portion of the realized gain is recognized and some is not (i.e., you will pay some of the taxes due upon sale, but not all). Examples include: 1. Exchanges which are a combination of a 1031 exchange and an installment sale, with the loan documents payable to the exchanger; 2. Exchanges involving replacement property which is comprised of business or investment property and personal property. You can be fully tax-deferred on these exchanges if you do a multi-asset exchange, covering both the real and personal property; 3. Exchanges where a portion of the gain is taken in cash or other “boot” property, and the balance of the gain is invested in qualifying replacement property.
There are several important benefits of delayed exchanges:

  1. Delayed exchanges allow the exchanger additional time to find and close the purchase of replacement property. The replacement need not be identified or acquired when the relinquished property is sold. The exchanger can consider market opportunities rather than feel pressured to immediately identify and purchase all replacement property. A word of caution: the 45-day Identification period is probably the most difficult rule to come out the Final Regulations. We strongly suggest that exchange clients have several properties ready to identify as potential replacement properties before they close on their relinquished property. Otherwise, the exchangers may learn to their dismay, just how rapidly forty-five days can disappear.
  2. As a practical matter, it is often extremely difficult to coordinate concurrent closing, especially if the relinquished and replacement property transactions are effected in different counties and states. For example, funds from the sale of the relinquished property are almost always used to pay for the replacement property. Funds should flow through the Intermediary, and even if the closings are in the same state or at the same escrow company, it’s almost impossible to effectively make the proceeds of the relinquished property payable to the Intermediary, and then have them instantly available for funding the closing of the replacement property on the same day.
  3. In simultaneous transactions, recording at different locations, it is extremely difficult to insure that the exchangers’ transfer of the relinquished property occurs before, or simultaneous with, the exchangers’ receipt of the replacement property, as current law appears to require.
  4. In almost every simultaneous exchange, only one potential taxpayer is able to take advantage of trading “even or up” in equity and debt. The other party to the exchange is usually, by necessity, exchanging down in both equity and debt, leaving “boot” to be taxed at the current capital gains rate. If each party completed a delayed exchange, both could exchange “even or up” in equity and debt and effect a completely tax-deferred scenario for both parties.
Yes. Fully tax-deferred exchanges are affected when you properly identify and receive like-kind qualifying property of equal or greater value, subject to equal or greater debt, without any actual or constructive receipt of cash or other non like-kind property.
The primary advantage of a 1031 exchange is the preservation of investment capital by deferring payment of capital gains taxes. If you sell property (rather than exchanging it) you must pay taxes on any recognized gain. Capital gains tax is usually 20% to 25% of your gain, plus any state taxes. In a tax-deferred exchange, all your profit (both cash and carry-backs) may be used to acquire replacement property. Astute investors understand that 1031 exchanges allow greater net profits, the purchase of larger or additional investment property and a faster pyramiding of wealth.

Exchanges are a great tax planning mechanism allowing the deferment of taxes until the taxpayer is in a lower tax bracket or until a more beneficial tax rate exists.

Reasons for exchanging include: consolidation of several smaller properties into one larger investment to facilitate easier management or better cash flow, shifting investment from one area or locale to another to take advantage of local market opportunities, avoiding “deferred maintenance” by trading out the older properties into newer ones and diversification of investment portfolios by trading out of a single property, or type of property, into various investments or multiple properties.

Only if and when you elect to sell, as opposed to exchange, your replacement property.
The Closing Agent acts upon instructions from all parties to the transaction. To leave the funds in the escrow or trust account requires the Exchanger to give such instructions to the Closing Agent. This control is called “constructive receipt” and invalidates the exchange.
It is important that you know exactly where your exchange funds are deposited and how they are kept secure. We use the following measures to ensure the security of every exchange client’s funds:

(a) Your exchange funds are deposited in a segregated deposit account with an independent bank. One client’s exchange funds are never commingled or pooled with another client’s funds. (b) Your exchange funds are FDIC insured up to $250,000.

The fee varies depending on the complexity of the exchange but usually varies from $500 to $3,000.
Competent legal and/or accounting counsel is always recommended and should always be engaged. Tax laws are continually changing and I.R.C. Section 1031 exchanges are often extremely complex or highly technical, requiring guidance and answers to interpretive questions best left to competent legal or tax advisors. The Gustavson Group will assist you in procuring such help at your request.
The Revenue Reconciliation Act of the 1989 Legislative session effected a two year related party restriction wherein property conveyed to a related party is now subject to a two year holding period. If either the exchanger or the related party disposes of the acquired properties within the two year period, the non-recognition provisions will not apply and the exchanger must recognize gain as of the date the disqualifying disposition occurs. A related party is defined by cross reference to I.R.C. Section 267(b) which covers a wide range of relationships including family members, corporations, partnerships and trusts.
Yes. You can exchange one relinquished property into one or more replacement properties, and vice versa.
Yes, for a full tax-deferred exchange. To defer all taxes otherwise due upon sale, the aggregate fair market value of all replacement property received must be equal to or greater than the aggregate fair

market value of all relinquished property. If you trade down in either equity or debt, the difference may be taxable to the extent of your gain.

Yes, and you have several options should you choose to combine a 1031 exchange and an installment sale, with the loan documents payable to the Intermediary:

a. Option #1 – Exchanger can try to locate a seller of a replacement property who is willing to take the Note as part of the consideration. If the seller is motivated and the Note is well-secured, this could be a viable approach. The Intermediary, as the Beneficiary of the Note and Trust Deed, would give the cash and Note to the seller in return for the replacement property.

b. Option #2 – The Intermediary could sell the Note to another party (usually at a discount) and apply the cash proceeds towards the acquisition of the like-kind replacement property. The cash proceeds would be added to the funds the Intermediary was holding from the sale of the relinquished property. Any discount from the sale of the Note would have to be offset with additional cash from the Exchanger before the acquisition property is closed.

c. Option #3 – In a separate transaction, the Exchanger may purchase the Note from the Intermediary. The Intermediary would, in turn, apply the combined funds from the Note sale and the sale of the relinquished property to acquire a replacement property. Care must be taken so that the Note sale is indeed a separate transaction. There is a possibility that the IRS could view the Exchanger’s receipt of the Note from the Intermediary as boot, or even worse, as constructive receipt, thereby endangering the exchange.

d. Option #4 – If Option #3 cannot be properly documented, the Exchanger may wish to lend $200,000 to the Buyer of the relinquished property outside of the closing in return for a Note and Deed of Trust to be secured by the property. The Buyer would then purchase the property from the Intermediary for $200,000 cash. The Intermediary now has $200,000 cash to use to acquire the replacement property.

Yes. An exchange is not a sale. A special exchange agreement is needed. The buyer of the relinquished property must agree to cooperate in completing the I.R.C. Section 1031 exchange, as that buyer will actually be purchasing the relinquished property from the Intermediary. Conversely, the seller of the replacement property will be asked to cooperate as the Intermediary is substituted in as the buyer of the replacement property. Such cooperation is usually secured through “intent and cooperation” language placed in the real estate contract for both the relinquished property and the replacement property. In addition, a comprehensive exchange agreement, assignment and substitution forms and a qualified escrow agreement should be prepared in accordance with the provisions of I.R.C. Section 1031. Each exchange is unique, and other documents specific to each individual exchange may need to be prepared and executed.
Not all property transferred in an exchange must be of like-kind. Other property or money can be transferred in addition, without invalidating the exchange. Such non like-kind property is called “boot”. In general, boot is only taxable to the extent of the realized gain. Transactions involving boot must be very carefully structured so as not to invalidate the qualifying portion of the trade. The receipt of money or non like-kind property will cause the realized gain, if any, to be recognized to the extent of the sum of money and the fair market value of the property received. In other words, you have to pay taxes on any money or other non like-kind property you receive in an exchange. Properly configured exchanges are structured so as to eliminate or minimize boot.
Constructive Receipt occurs in an exchange when a taxpayer has the unrestricted right to access cash or boot, whether or not such right is exercised, and regardless of whether there is actual or physical receipt of the cash or boot. Any cash or boot received by the exchanger will cause recognition of gain (i.e., taxable income).
“Debt Relief” or “Mortgage Relief” is any net reduction in the amount of liability on the replacement property after the exchange, as compared to the amount of liability on the relinquished property just prior to the exchange. It will be considered boot and will result in the recognition of gain unless offset by the payment of additional cash by the exchanger.

Direct-deeding streamlines transactions allowing for easier and quicker closing. More importantly, direct-deeding typically saves considerable additional expense, such as escrow fees, document preparation charges and transfer taxes otherwise incurred in “sequentially-deeded” transactions. Direct-deeding eliminates, to a great degree, the problems currently associated with environmental clean-up, as it eliminates the need for anyone other than the proper purchaser to appear in the chain of title. It also eliminates the chance that liens, clouds or judgments will attach to the relinquished or acquisition properties to the extent that they are attached to any individual chosen to facilitate the exchange. As the final regulations fully sanction direct-deeding, it should be employed at every opportunity.
The words “like-kind” refer to the nature or character of the property, not its grade or quality. For example, real property is not of like-kind to personal property because they are of a different nature and character. Conversely, vacant land, for example, is of like-kind to improved property as the two differ only in their grade/quality. Raw land, condominiums, single family residences, shopping centers, apartment buildings, farm and ranch land, commercial real estate, industrial property, second homes converted to investment property, and almost all other realty are of like-kind with respect to their intrinsic nature and character and may, therefore, be interchangeably exchange. With limited exceptions, any real estate meeting the above tests can be exchanged for any other real estate. In addition, the rules excepting incidental property from the identification requirements should not be construed as meaning such property will be considered like-kind realty. Remember, the final regulations

for “Multi-Asset/Personal Property” exchanges provide for very narrow like-kind qualification of any non-realty business or investment property, which may be transferred together with real estate in your transactions. For example, any furniture, manufacturing or other equipment, autos, or art work, etc. transferred in addition to real estate is not like-kind to realty received as replacement property. The definition of realty is determined by each state in the United States, and any person wishing to exchange should determine the definition of realty according to the state or states where the relinquished and replacement properties are located.

A Safe Harbor is a “suggestion” from the IRS. They are not substantive rules, but to the degree that auditing agents understand them, they will be applied as “Holy Writ”. At this point in our outline, I would like to quote B. Wyckliffe Pattishall, Jr., President of Chicago Deferred Exchange Corporation, and one of the experts in America on the subject of tax-deferred exchanges: “The Deferred Exchange Regulations provide taxpayers with “safe harbors” which may be employed in structuring and securing both simultaneous and delayed tax-deferred exchanges. My purpose in what follows is to provide assistance in navigating the narrow channels created by the regulations through hazardous waters. The importance of staying within the channels is more critical today than prior to the issuance of regulatory guidance when a smattering of case law and a limited number of public rulings were the only channel markers. In the words of the Barker Court, ‘At some point, the confluence of some sufficient number of deviations will bring about a taxable result.’ The very existence of the safe harbors and bright line tests in the regulations create a burden on tax practitioners to make ever effort to structure exchanges within these guidelines, where the tax risk of the transaction can be minimized. Failure to meet the technical requirements of the safe harbors is likely to generate a number of malpractice claims in the future. The regulations provide practitioners with clear channels to safe harbors, but the sides of these channels, and you will dispose, sometimes magically, of the issues of agency, constructive receipt, the like-kind standard, and the exchange requirement. Venture outside the channels, and you invite disaster…practically speaking, auditing agents will probably disallow exchanges which do not meet the requirement of the safe harbors and leave the issue for resolution at the appellate conference. In fact, at the time of this writing (late 1994) auditing agents are recommending exchange transactions for litigation by the government where strict observance of the regulations is not apparent.”
  1. Non-Cash Security for Buyer’s Performance: Mortgage or Deed of Trust Standby Letter of Credit Third Party Guarantee
  2. Cash Security for Buyer’s Performance: Qualified Escrow Qualified Trust
  3. Qualified Intermediary The only Safe Harbor which also applies to a Simultaneous Exchange
  4. Exchangers May Receive Interest After Completing The Exchange
All replacement property to be acquired in the exchange must be “unambiguously described” by legal description, assessor’s parcel number or tax map key or equivalent number, or address, distinguishable name, etc., and made in a written document executed by the exchanger and hand-delivered, mailed, telecopied or otherwise sent to a person involved in the exchange who is not a disqualified party – preferably the Intermediary. A single exception to the identification requirement is provided, which deems any replacement property actually acquired by the exchanger within the 45-day Identification Period to be duly identified property. You should document the sending and/or delivery of the identification letter and confirm their receipt. Every attempt should be made and reviewed for conformance and accuracy in advance of the last day of the Identification Period. A non-conforming identification sent by fax or mail and received by the Intermediary on the last day of an Identification Period which ends over a weekend, may at best be reviewed on the Monday following the expiration of the Identification Period. It would then be too late to make any required changes, resulting in an invalid exchange.
One of the following three rules must be followed when identifying single, multiple or alternative replacement properties:

  1. Three properties of any value may be identified. This rule is known as the “Three Property Rule”. You may acquire either one, two or all three properties identified.
  2. Any number of properties may be identified, provided that as of the end of the Identification Period, the aggregate fair market value of all identified replacement property does not exceed 200% of the fair market value of all relinquished property. This rule is known as the “Two Hundred Percent Rule.” You may then acquire any number of those properties identified.
  3. Any number of properties may be identified, as long as the exchanger acquires replacement property whose aggregate fair market value is at least 95% of the aggregate fair market value of all identified properties. This rule is known as the “Ninety-Five Percent Rule.”
Only if you have relied on the 95% Rule. In other words, you have identified more than three properties which aggregate more than 200% of the fair market value of the relinquished property. In such circumstances, the technical requirement is satisfied if you acquire 95% of the identified property. This rule, however, is very difficult to follow, as just one problem with one identified property could prevent you from acquiring 95% of all identified property.
The Code provides that property not yet in existence is properly identified if the underlying land (together with any existing improvements) is identified, and the improvements to be constructed are identified in “as much detail as is practicable at the time of the identification.” Plans and construction contracts should be referenced in the identification, providing for such documents to be later attached in the event they are not available within the Identification Period.
The Regulations provide that property which

(i) “is incidental to a larger item” and (ii) “is typically transferred in standard commercial transactions” (appliances, etc.) and

(iii) “does not exceed 15% of the value of the larger item, need not be specifically and separately identified.

Identifications may be revoked, if such revocations are made in a written document, signed by the exchanger, and sent to the Intermediary before the end of the Identification Period. If the original identification was made in an exchange agreement, it may be revoked by an amendment to the exchange agreement, signed by and sent to all parties to the exchange agreement.
An Intermediary is required in all transactions other than those outlined below:

(a) A two party simultaneous exchange. (*Please see note below.) Benefit: Simple and Cost-Effective NOTE: The only safe harbor recommended by the Treasury Department for simultaneous exchanges is the use of a Qualified Intermediary.

(b) The ABC Exchange, also called the Alderson or Reverse Missouri Waltz Exchange. (Buyer buys replacement property from the seller, and then exchanges it with the exchanger for the relinquished property. These steps all occur simultaneously.) Problem:

(i) potential for hazardous waste liability to attach to buyer of replacement property, as buyer passes through the chain of title and deeds to the exchanger, and

(ii) the potential for liens, clouds and judgments which might be filed against the buyer of the relinquished property to attach to the replacement property, as the buyer enters the chain of title.

(c) The ABC Exchange, also called the Baird or Missouri Waltz Exchange. (The exchanger and the seller of the replacement property exchange properties, and the seller, who now owns the relinquished property, sells it to the buyer. These steps all occur simultaneously.) Benefit: Minimizes transfer tax consequences by having the double title transfer on the relinquished property, which has a lower value. Problem:

(i) potential for hazardous waste liability to attach to seller of the replacement property, as seller passes through the chain of title on the relinquished property and deeds to the ultimate buyer, and

(ii) the potential for liens, clouds and judgments which might be filed against the seller of the relinquished property, as the seller enters the chain of title.

(d) The Pot Exchange, (any number of people put their “haves” and “wants” into one pot, and a single escrow officer or closing agent sorts everything out and delivers the appropriate “goods” to each party, whether that be property, cash or paper, etc. This is accomplished by a direct deed system, and must occur simultaneously.) Benefit: Avoids or minimizes transfer taxes or potential hazardous waste liability. Problem: Requires one very accurate and dedicated closing agent or escrow officer. A Qualified

Intermediary is always required for the two remaining types of exchanges:

(e) The Simultaneous Exchange With an Intermediary, and

(f) The Delayed Exchange With an Intermediary.

An Intermediary is that entity or person who:

(a) acts as the middle-man or “straw-man” in exchange transactions;

(b) holds the proceeds of the sale of the relinquished property;

(c) does any buying of replacement property or selling of the relinquished property necessary on behalf of the exchanger. The Intermediary typically acquires the relinquished property from the exchanger and sells it to its ultimate buyer, using the proceeds of the sales to acquire and convey to the exchanger the replacement property. Your Intermediary should be a corporation rather than an individual in order to protect against your Intermediary’s death, disability, incapacity, judgment liens, etc. Furthermore, intermediaries should offer mechanisms and procedures designed to protect your transactions, together with any funds held, through the use of letters of credit, third party guarantees, bonding and Errors and Omissions insurance. It is also extremely important for an Intermediary to employ proper custodial procedures for sale proceeds and other funds held in segregated, restricted accounts, through the use of a “Qualified Escrow” or a “Qualified Trust”. The final rules for tax-deferred exchanges created a new category of accommodator or facilitator called a “Qualified Intermediary,” and provided for certain tests which must be met in order to “qualify.” In addition, these rules prescribe certain procedural requirements which all Qualified Intermediaries must meet, together with prerequisite use of an exchange agreement containing express and specific language. As the Internal Revenue Service has vowed to pursue any taxpayers who use accommodators in deferred exchanges other than Qualified Intermediaries, exchangers should be extremely careful not to breach this requirement.

The Intermediary typically serves many functions during an exchange:

  1. If the exchanger actually or “constructively” receives any or all of the proceeds of the sale of the relinquished property, the exchange will not be valid. (This rule would not apply to a percentage exchange, where the exchanger may receive the percentage of the sale proceeds which result from the percentage of the sale not included in the exchange.) In order to insulate the exchanger from such “constructive receipt”, the Intermediary holds the proceeds of the sale of the relinquished property in a segregated, restricted account.
  2. To qualify for tax deferment under I.R.C. Section 1031, exchanges must be pursuant to a written exchange agreement. Some intermediaries provide this documentation, precluding the exchanger’s needs to engage separate legal counsel to prepare the exchange agreement. As significant additional costs are incurred if the exchanger must engage counsel to draft such documentations, XSI provides the exchange agreement and all other required exchange documents at no additional cost.
  3. Tax-deferred exchanges must, in essence, constitute a reciprocal exchange of properties between two parties, notwithstanding the fact that there are almost always three, four or occasionally more than four parties participating in an exchange. An important role of the Intermediary is to become the exchanger’s other party to the exchange. Technically, the exchanger is trading property with the Intermediary. This explains why the relinquished property is conveyed to the Intermediary first, and then to the ultimate buyer. Likewise, the replacement property is transferred first to the Intermediary and then to the exchanger.
  4. Exchange transactions are often extremely complex. A good Intermediary helps explain, conform and manage all aspects of the transaction, facilitating document signatures, escrow closing and the timely cooperation and performance of the parties to the exchange.
No. “Disqualified Persons” may not be Qualified Intermediaries. With limited exceptions, a Disqualified Person is any party who has acted as your agent, employee, attorney, accountant, investment banker/broker, or real estate agent or broker within the two-year period ending on the date of the first transfer of any relinquished property. Also disqualified are the family members of the Disqualified Persons, as well as partnerships, corporations and other entities in which you, or your related party, own directly or indirectly, more than a 10% interest.

Example: Your attorney owns 11% of the stock in his law firm, and his wife owns her own Intermediary firm. You wish to use his wife’s Intermediary firm as your Qualified Intermediary. If your attorney has done any work for you in the last two years, other than strictly I.R.C. Section 1031 tax-deferred work, his wife’s firm is “disqualified” to act as your Qualified Intermediary. Conversely, if ten law firms each own 10% of a corporation organized to act as a Qualified Intermediary, you could use that Qualified Intermediary even though your law firm was one of the ten owners.

No, with extremely limited exception. After much confusion, the Internal Revenue Code was amended in 1984 to specifically prohibit the exchange of partnership interests. Similarly, the exclusion clarified the law that a partnership interest, whether general or limited, cannot be exchanged for an interest in real property without recognition of gain. Some highly technical and relatively complex structures have been employed in an attempt to legally circumvent the restrictions against exchanges of partnership interests. Skilled legal and/or accounting counsel must be engaged for such transactions.
It is generally accepted that, if a partnership is dissolved and the partner’s partnership interest are converted upon distribution into divided or undivided real property ownership interests, the partners may then be able to trade such real property interests under I.R.C. Section 1031, provided that the partnership dissolution and distribution occurs long enough before or after the exchange to satisfy the “held for investment” requirement. Such liquidation and/or conversion of partnership interest involves highly technical questions and favorable treatment of such transactions is by no means assured. Exchangers must secure qualified legal or accounting counsel before attempting these transactions.
Yes! Partnerships and corporations are legal entities and, as such, are not prohibited from exchanging partnership property (as opposed to a partner’s partnership interest) under I.R.C. Section 1031. Remember, these transactions necessarily involve the entire partnership trading its real property interest.
Generally, real property of “like-kind” which is not identified as condemned property (a 1033 exchange) or your personal residence (a 1034 exchange), and was not acquired for resale or considered inventory or dealer property may be traded under the I.R.C. Section 1031 exchange rules. The property relinquished in the exchange must have been either productively used in your trade or business, or held for investment, i.e., you must have affected a “qualified use” of the property. Likewise, it must be your intention as you acquire your replacement, to either hold that property for investment or use it for a business purpose.
Yes. The following property is specifically excluded under I.R.C. Section 1031 and therefore cannot be of “like-kind”:

  1. Stock in trade or other property held primarily for sale;
  2. Stocks, Bonds, Notes or other Securities or Evidence of Indebtedness or Interest;
  3. Interests in a Partnership;
  4. Certificates of Trust or Beneficial Interest;
  5. Chooses in Action;
  6. Real Property located within the United States is no longer like-kind with Real Property located outside of the United States.
How long one must hold property in order to qualify for tax deferment under I.R.C. Section 1031 is unclear. While it is generally accepted that a one-year to two-year period may be sufficient, there is no statutory holding period. Although the IRS has taken the position that a transaction will not qualify under 1031 if a property acquired is immediately disposed of (particularly if such disposition is prearranged), conflicting precedents exist. Exchangers are well advised to use extreme care in structuring exchanges of property with short holding periods and quick resale.
As a result of the Revenue Reconciliation Act of 1989, real property located within the United States and real property located outside of the United States are no longer of like-kind. However, foreign property may still be exchanged for other foreign property.
Special provisions apply to leasehold property. While owners of leasehold property do not possess a fee simple interest, a leasehold of 30 years or longer (including optional renewal periods) is deemed to be of like-kind to fee simple property. Leaseholds of less than 30 years duration may only be traded for other leasehold property with remaining lease terms of less than 30 years. Again, remember that optional renewal periods are included in determining whether a lease for a period of years is of like-kind.
No. Personal residences should be exchanged under the relatively less demanding provisions of I.R.C. Section 1034 and cannot be exchanged under I.R.C. Section 1031.
In addition to the non-qualifying property previously discussed, examples of property which probably will not meet the qualified use test are:

(a) Land which was acquired for the express purpose of subdivision and resale and only held long enough to effect such subdivision and resale;

(b) Homes held for sale by speculation builders, such as builder’s inventory of unsold homes;

(c) Any transaction which constitutes a sale followed by a reinvestment in other property, whether or not the replacement property is considered to be like-kind, wherein the transfers are no reciprocal and interdependent, and are absent in an exchange agreement.