How To Do A 1031 Tax Deferred Exchange

Yesterday's blog reviewed examples of performing a 1031 tax deferred exchange and how boot is either avoided or recognized as a gain. Today, we'll address the basic flow of the entire process, from selling the original property through the closing on the new property.

The most important step in getting started with a 1031 tax deferred exchange is hiring the right real estate company to ensure that the process is successful from beginning to end. Miss one key step and all of your work might not be allowed under the Internal Revenue Code Section 1031!

Selling the Original Property

• List your property "For Sale" with Real Estate Company. Include language in the listing advising buyers that this will be a 1031 sale and Buyer must cooperate with Seller regarding terms of the 1031.
  
• Begin search for replacement property. While not important to identify it at this stage, it is important that all available options are explored so that future time constraints can be met with little or no stress involved with the exchanger.
  
• Negotiate Contract with competent buyer and include appropriate language advising all parties of 1031 tax deferred exchange.
  
• Inform the intermediary that a contract has been executed (the law firm or title company handling the closing will be able to provide an intermediary).
  
• Follow the guidance of the intermediary regarding closing. The proceeds of the sale will be placed in the intermediary's account, awaiting the closing of the replacement property.
  

Buying the Replacement Property

• After closing on the original property, the investor has 45 days to identify the replacement property. There are rules on how this is done, and they will be the focus of a future blog. There is no reason why this could not occur during the closing process above, and a simultaneous closing occur. This will be the best for the investor, as it will allow for instant reinvestment of the equity sitting in the intermediary's account.
  
• Make sure the replacement property optimizes the tax benefits for the investor. The replacement property should be of equal or greater value than the original property, the mortgage (if any) should be of equal or great amount than the original property, and the equity should be of equal or greater amount than the original. By doing all three of these, the investor will avoid "boot" and will not recognize a gain.
  
• Notify the intermediary when the contract is executed, and ensure the appropriate 1031 language is in the contract, requiring the Seller to cooperate with the Buyer for the purposes of the 1031.
  
• Ensure that the closing of the replacement property occurs within 180 days of the closing on the original property. Again, much sooner is smarter for the investor.
  

The key to conducting a successful 1031 tax deferred exchange is to remember that you are dealing with the inflexible IRS! They have very specific rules on each step of the process, not guidelines on how it should be done. Make sure that you and your real estate company play by these rules!