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FAQs What is a Tax Deferred Exchange? A tax deferred exchange is simply a method by which a property owner trades one or more properties for one or more other properties without having to pay any federal income taxes on the transaction, and often with no state incomes taxes. In an ordinary sale transaction, the property owner is taxed on any gain realized by the sale of the property. But in an exchange, the tax on the transaction is deferred until some time in the future, usually when the newly acquired property is sold. 
top Who can do an Exchange? Exchanges can be done by individuals, trusts, corporations, partnerships, limited liability companies, or any other business entity.
top What are the Disadvantages of an Exchange? The taxpayer must reinvest the net proceeds from the disposition of the relinquished property in like kind property rather than other types of more liquid investments, such as stocks or bonds. There may be additional escrow fees, attorney's fees, accounting fees, and the intermediary’s fees. The replacement property will have a carryover tax basis from the relinquished property. This means that more taxable gain will be realized when the replacement property is sold than would have been realized if the replacement property had been acquired through a straight sale and purchase. There will also be less depreciation deductions if the replacement property is depreciable.
top How is an Exchange Structured? Exchanges may be simultaneous or delayed. In a simultaneous exchange with a qualified intermediary, title to the relinquished property is transferred to the buyer. The buyer pays cash to the qualified intermediary. The qualified intermediary pays cash to the seller who transfers title to the replacement property to the taxpayer. In a delayed exchange, the taxpayer has 45 days to identify the property he or she wants as the replacement property. The taxpayer must acquire that replacement property within 180 days of the transfer of the relinquished property (or the due date of the taxpayer's federal income tax return (including extensions) for the year in which the relinquished property was transferred). There are no extensions or exceptions to these time limits. The other requirements of the IRS regulations must also be met.
top How are the Exchange Funds Invested? If you actually or constructively receive the exchange funds, the exchange will be taxable. Therefore, the exchange funds must be held by the qualified intermediary, or an unrelated third party escrow or trustee. All exchange funds held by 1031 Services, Inc. are placed in qualified escrow accounts with Beneficial Mutual Savings Bank. We do not commingle your exchange funds with the funds of any other client for investment purposes. The account is an interest-bearing, money market account with daily liquidity and is FDIC insured for up to $250,000. For more information, see "Why are Your Exchange Funds Secure With Us?". You receive a monthly bank statement and 1099-INT directly from the bank and also have the option of viewing your account on-line at the bank's website. The account requires your signature to the bank for any withdrawals. We can also work with the bank of your choice, but an additional account set up fee will apply.
top What are the Requirements of an Exchange? There are several requirements for a valid exchange. 1. Types of Property. In general, all property, both real and personal, can qualify for tax-deferred treatment. However, some types of property are specifically disqualified, namely: property held primarily for sale; stocks, bonds or notes and REIT interests; other securities or evidences of indebtedness or interest; interests in a partnership; certificates of trusts or beneficial interest; and chooses in action (e.g. interests in lawsuits). 2. The Purpose Requirement. The taxpayer's relinquished property and replacement property must be held for productive use in a trade or business or for investment. Property acquired for immediate resale will not qualify. Property held or acquired as a principal residence or primarily as a vacation home will also not qualify. 3. The Like Kind Requirement. Replacement property acquired in an exchange must be "like-kind" to the property being relinquished. All real property is like-kind to other real property. But real property is NOT like-kind to personal property. 4. The Exchange Requirement. IRC §1031 specifically requires that an exchange take place. That means that property must be exchanged for other property, rather than sold for cash. The exchange distinguishes an IRC §1031 tax deferred transaction from a taxable sale and purchase. Today, deferred exchanges are accomplished through qualified intermediaries to insure that they meet the exchange requirements of IRC §1031.
top How do the Identification Rules Operate? Identification of all replacement property must be made in writing, signed by the taxpayer, and sent to a party to the exchange on or before midnight of the 45th day of the exchange period. The written identification is usually sent to the qualified intermediary. The identification must be specific as to what the taxpayer intends to purchase. All identifications must give either the street address or legal description of the property and state that the taxpayer is identifying it as replacement property. If improvements are to be constructed on the property, they must be described in as much detail as is reasonably practical. The taxpayer may identify one or more properties in the written identification. In general, the number of replacement properties that may be identified is: 1). Up to three properties, without regard to their fair market value (The Three-Property Rule); 2). More than three properties, but the total fair market value of all these properties at the end of the 45-day identification period does not exceed 200% of the total fair market value of all properties relinquished in the exchange (The 200% Rule).
Any property actually received during the 45-day identification period is treated as properly identified, but does count as a property for the purposes of the Three Property Rule or the 200% Rule if the taxpayer identifies additional replacement property in a written notice. If the taxpayer exceeds both the Three-Property Rule and the 200% Rule, then the properties acquired after the 45th day do not count as replacement property in the exchange (unless the taxpayer acquires 95% of all the identified properties).
top How is Taxable Gain Computed in an Exchange? As a GENERAL rule of thumb, you must trade up or equal in value AND equity to totally defer the taxable gain in your exchange. HOWEVER, there are many exceptions to this rule and your taxable gain can be impacted by closing costs, including rent prorations and security deposits. Your taxable gain also can be impacted by several tax provisions, including depreciation and other recapture items, net operating losses, and special corporate and partnership tax provisions. We do not review your tax returns for items that may affect your taxable gain, and we do not undertake to calculate taxable gain in your exchange. YOU SHOULD CONSULT YOUR TAX ADVISOR PRIOR TO COMMENCING THE EXCHANGE REGARDING THE COMPUTATION OF POTENTIAL GAIN FROM THE EXCHANGE AND ANY SPECIAL TAX ITEMS THAT MAY IMPACT YOUR TAX CONSEQUENCES.
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