- Select QI
- Set Up 1031
- Closing #1
- 45 Day ID
- New Closings
- Report 1031
Many 1031 Exchangers are unaware that the 1031 exchange industry is almost totally unregulated. Granted, there are a handful of states that require some licensing. But by and large, you are on your own when it comes to ensuring that your exchange is facilitated properly.
For this reason, you need to be aware of two very important pitfalls to avoid as you select a Qualified Intermediary for your exchange.
PITFALL #1, make absolutely sure that your personal data and transactional info will be fully secured during the course of your exchange, and
PITFALL #2, make sure that your exchange proceeds will be held on deposit within a safe custodial structure and that your exchange funds will not be commingled with the funds of others. This means either a Qualified Escrow Account or a restricted 1031 account. We suggest using a Qualified Intermediary which actually creates their accounts in the name of the Exchanger and with the Exchanger's tax identification number.
In addition, remember that the logistics and mechanics of your exchange are critical as well. Before you set up your exchange it is important that it carefully planned with the help of an experienced, competent and creative legal and exchange concierge or exchange professional. Preferably one who is completely familiar with the tax code in general, not just Section 1031, and one who has extensive experience in doing many different kinds of exchanges. Thorough planning can help avoid many subtle exchanging pitfalls and also ensure that the Exchanger will accomplish the goals for which the transaction is intended.
Be sure that your exchange is set up and your exchange documents are prepared prior to the closing of your relinquished or sale property. When your Qualified Intermediary creates the documents which will be memorializing your exchange, they need to include an assignment of your purchase and sale agreement to the Qualified Intermediary. This essentially creates a scenario where the Qualified Intermediary is selling the old property, having the exchange funds placed into a trust account, and subsequently acquiring a replacement property the Exchanger identifies, and acquiring that replacement property and having it deeded to the Exchanger.
In addition, the facilitator needs to have your exchange trust account set up and ready to receive your proceeds by wire from the Closer when your old property closes.
If the exchange is closing in a reverse exchange format, the set up will be different because the replacement property will be acquired first, necessitating an entirely different approach to the creation of the exchange documents with the acquisition of the replacement property prior to the closing of the relinquihed property.
When the closing occurs all the exchange documents and settlement statements are executed and the exchange proceeds hit the Exchanger's trust account, this will start the Exchanger's 45 and 180 day exchange clock. Meaning that the Exchanger will need to identify candidate or new properties within 45 days of the closing and be prepared to close all the new properties within the 180 day exchange period.If you are closing your relinquished property sale late in the year, remember that you may need to file an extension of your tax return due on April 15th in order to get the full 180 day period to complete your exchange.
Probably the most difficut part of any tax deferred exchange is meeting the identification of replacement property requirement within 45 days from the closing of the old property.
The Internal Revenue Service requires that when the Exchanger identifies candidate or trageted repolacement properties, they must utilize one of the rules set forth by the reasury Reguations.
According, here are the three rules for the correct identification of replacement properties. They are:
1) The Three Property Rule dictates that the Exchanger may identify three properties of any value, one or more of which must be acquired within the 180 Day Exchange Period.
2) The Two Hundred Percent Rule dictates that if four or more properties are identified, the aggregate market value of all properties may not exceed 200% of the value of the Relinquished Property.
3) The Ninety-five Percent Exception dictates that in the event the other rules do not apply, if the replacement properties acquired represent at least 95% of the aggregate value of properties identified, the exchange will still qualify.
As a caveat we should mention that these identification rules are absolute. No deviation is possible and the Internal Revenue Service will grant no extensions apart from a disaster declaration.
* Ironically, although only approximately 3-5 percent of exchanges are audited, the few exchanges which don't pass upon audit, typically they fail because of discrepancies in identification.
The Exchanger will need to be capable of closing all the new replacement properties within the statute 180 day exchange period. This means having the right, title, and interest in all replacement properties prior to the 180 day deadline.
The same holds for reverse exchanges. However that typically means the replacement property is acquired on day one, and the relinquished property is successfully closed and transferred to a new buyer within 180 days.
There are however instances where some exchanges can exceed the typical 180 day exchange window. These are transactions, usually reverse, build to suit construction exchanges which are completed outside of the normal safe harbors established with Section 1031 of the Internal Revenue Code. These are exchange transactions which should only be undertaken with the assistance of an extremely well qualified Qualified Intermediary who is experienced in these more complex exchanging scenarios. If you are contemplating a construction or improvement exchange or an exchange which you expect needs to exceed the 180 day window, contact us for a referral to a qualified facilitator. There are only one or two Qualified Intermediaries nationally who are experienced enough and capable of completing these types of exchanges seamlessly.
Exchangers must be prepared to report their exchange to the Internal Revenue Service by including an IRS Form 8824 with their tax return. It is a straightforward one page form that will lstv the relinquished property, replacement property, and recap the cost basis which is associated with the exchange.An image of the IRS Form 8824 is below:
Planning and Advice
Since tax deferred exchanges involve a minimum of two properties, and often many more, they include some extraordinary logistics because of the necessary multiple closings and the difficulties associated with many transactional moving parts. For this reason, and because a significant amount of deferred gain treatment is at stake, every exchange deserves to be planned by the Exchanger beforehand. It usually only takes a few minutes with a 1031 exchange professional for an Exchanger to theoretically walk through the entirety of the exchange logistics before starting. This type of pre-planning can often assist an Exchanger in avoiding several exchanging pitfalls and create workarounds or mitigation strategies before any problems can arise.Is Your Personal Data Secure?
The online world in which we live today can be dangerous. Especially for those involved in the sale and transfer of real estate. Your personal data is always at risk of being hacked or compromised, and it is even more risky to allow the transport of your personal data across free email platforms like Gmail and Yahoo. Frankly, this is one of the primary rationales we utilize whenever we refer an Exchanger to any Qualified Intermediary. We encourage every Exchanger to insist that their exchange is processed within a fully encrypted environment, to ensure that no data is ever at risk. That is also why we will refer you to a processor that will set up your account and securely send you login credentials, so you can log in to a secure ecosystem where you can safely interact with your exchange documents, view your trust account activity, or communicate with your 1031 Coordinator.Are Your Exchange Funds Secure?
For many years, Qualified Intermediaries commingled the exchange proceeds of their Exchangers and provided for the sub-accounting of individual Exchanger balances on their own books. Over time, as banking software became more sophisticated, it was possible to set up individual accounts for the benefit of Exchangers (FBO), however the accounts were always in the name of the Qualified Intermediary and never required the approval of the Exchanger to transfer and exchange funds. One step forward for 1031 Exchangers was the introduction of Qualified Escrow Accounts or QEAs. This is essentially a three-party agreement between the bank, the Intermediary and the Exchanger which ensures that a bank officer must sign off for the transfer of any 1031 funds. This was a dramatic step forward for Exchangers, but has been utilized very rarely because of the traditional extra expense of setting up the individual QEA at the bank. If an Exchanger does not opt for the extra expense associated with a Qualified Escrow Account they should insist upon a Qualified Intermediary who uses a banking structure that can be trusted. We encourage the use of Qualified Intermediaries with a banking regimen where they actually set up each individual Exchanger's account in their name, and with their tax identification number. This makes it very clear who's exchange funds are on deposit and also requires that every Exchanger must provide written disbursement instructions, usually provided through secure e-signature for the wiring or movement of any 1031 funds.Facilitating Within an Encrypted Environment?
Ensuring that your exchange is facilitated and processed within an encrypted environment means that your personal and transactional data is never at risk because it is electronically secured. It also means that your access to your exchange related data and trust account balances will typically only be available via login credentials which are required for you to view your exchange inforrmation. Encryption is the backbone provided by the Qualified Intermediary that protects you and your data: