What is a 1031 Exchange?

A S1031 tax-deferred exchange preserves equity and may indefinitely defer capital gains taxes, provided you comply with strict IRS guidelines. Four parties are involved:

1. The Exchanger: the party initiating an exchange to defer capital gains taxes on a relinquished property.
2. The Buyer: the party acquiring the Exchanger's property.
3. The Seller: the party selling a replacement property to the Exchanger.
4. The Qualified Intermediary (Accommodator): the third-party entity holding the Exchanger's sale proceeds for future disbursement upon the close of the replacement property acquisition.

What is Tenant in Common (also known as Undivided Fractional Interest)?

The purchase of a tenant in common (or undivided fractional interest) structure allows investors to purchase an interest in a real estate asset with other co-owners. The investor acquires a percentage ownership (title and deed) and receives rental income while receiving the tax benefits of traditional real estate ownership. The investors (co-owners) own and control the property, not a third party. Unlike partnership real estate, TIC ownerships give each owner the same ownership rights regardless of the equity invested. This element of the investment structure puts no individual owner (or group of owners) in direct control of the property over any other investor(s).

What happens if I fail to close on my 1031 exchange?

You will have to pay your capital gains taxes. Failure to close is the top reason investors reveal as to why they pay capital gains. By identifying a FlexTIC property, you can reduce your potential tax risk, and avoid a failed closing. If you fail to close on other identified properties, you are able to move all your proceeds into the TIC property you identified.

1031 Timeline

Identification Period: Within 45 days of selling the relinquished property you must identify suitable replacement properties. This 45 day rule is very strict and is not extended should the 45th day fall on a Saturday, Sunday, or legal holiday.

Exchange Period: The replacement property must be received by the taxpayer within the "exchange period," which ends within the earlier of . . . 180 days after the date on which the taxpayer transfers the property relinquished, or . . . the due date for the taxpayer tax return for the taxable year in which the transfer of the relinquished property occurs. This 180-day rule is very strict and is not extended if the 180th day should happen to fall on a Saturday, Sunday or legal holiday.

Is there any limit to the number of properties that can be identified?

3-property rule: You may identify any three properties as possible replacements for your relinquished property. More than 95% of exchanges use the 3-property rule.

200% rule: You may identify any number of properties as possible replacements for your relinquished property as long as the aggregate value of those properties does not exceed 200% of the value of your relinquished property.

95% exemption: You may identify any number of properties as possible replacements for your relinquished property as long as you end up purchasing at least 95% of the aggregate value of all properties identified.

What are the requirements for a valid exchange?

* Qualifying Property - Certain types of property are specifically excluded from Section 1031 treatment: property held primarily for sale; inventories; stocks, bonds or notes; other securities or evidences of indebtedness; interests in a partnership; certificates of trusts or beneficial interest; and choices in action. In general, if property is not specifically excluded, it can qualify for tax-deferred treatment.

* Proper Purpose - Both the 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. The taxpayer's personal residence will not qualify.

* Like Kind - Replacement property acquired in an exchange must be "like-kind" to the property being relinquished. All qualifying real property located in the United States is like-kind. Personal property that is relinquished must be either like-kind or like-class to the personal property which is acquired. Property located outside the United States is not like-kind to property located in the United States.

* Exchange Requirement - The relinquished property must be exchanged for other property, rather than sold for cash and using the proceeds to buy the replacement property. Most deferred exchanges are facilitated by Qualified Intermediaries, who assist the taxpayer in meeting the requirements of Section 1031.

What is a Qualified Intermediary (QI)?

A Qualified Intermediary is an independent party who facilitates tax-deferred exchanges pursuant to Section 1031 of the Internal Revenue Code. The QI cannot be the taxpayer or a disqualified person.

* Acting under a written agreement with the taxpayer, the QI acquires the relinquished property and transfers it to the buyer.

* The QI holds the sales proceeds, to prevent the taxpayer from having actual or constructive receipt of the funds.

* Finally, the QI acquires the replacement property and transfers it to the taxpayer to complete the exchange within the appropriate time limits.

Why is a Qualified Intermediary needed?

The exchange ends the moment the taxpayer has actual or constructive receipt (i.e. direct or indirect use or control) of the proceeds from the sale of the relinquished property. The use of a QI is a safe harbor established by the Treasury Regulations. If the taxpayer meets the requirements of this safe harbor, the IRS will not consider the taxpayer to be in receipt of the funds. The sale proceeds go directly to the QI, who holds them until they are needed to acquire the replacement property. The QI then delivers the funds directly to the closing agent. If the taxpayer has already signed a contract to sell the relinquished property, is it too late to start a tax-deferred exchange? No, as long as the taxpayer has not transferred title, or the benefits and burdens of the relinquished property, he or she can still set up a tax-deferred Exchange. Once the closing occurs, it is too late to take advantage of a Section 1031 tax-deferred exchange (even if the taxpayer has not cashed the proceeds check).

What are the requirements to properly identify replacement property?

Potential replacement property must be identified in writing, signed by the taxpayer, and delivered to a party to the exchange who is not considered a "disqualified person". A "disqualified" person is any one who has a relationship with the taxpayer that is so close that the person is presumed to be under the control of the taxpayer. Examples include spouse, blood relatives, and any person who is or has been the taxpayer's attorney, accountant, investment banker or real estate agent within the two years prior to the closing of the relinquished property. The identification cannot be made orally.