The desire to avert or defer the payment of taxes incurred on the capital gains on property disposition is universal. While you cannot prevent paying your taxes, at least you can defer it, and this is what the delayed version of 1031 exchange of properties is all about. If you are still unaware of this 1031 exchange process, it is a property law in the United States Internal Revenue Code under Section 1031. It permits taxpayers to delay the capital gain, while they dispose off a property for investment, trade, or business purpose. The property under discussion could be anything, such as a vehicle, the trading of a player in a ball team, or a real estate deal. Talking about the latter, 1031 exchange real estate and 1031 exchange commercial real estate are the common ones among the 1031 exchange properties.
Types of 1031 exchange in brief
The section 1031 related to exchange of properties has been divided into various types, which include:
- Simultaneous 1031 exchange: Permits the sale of relinquished property and the purchase of replacement property, simultaneously.
- Delayed exchange: Non-simultaneous 1031 exchange of properties, which allows the entire property transaction to complete in 180 days.
- Improvement exchange: Lets the trader to improve the replacement property through the proceeds obtained by selling the relinquished property.
- Personal property exchange: Allows the trader to exchange personal property, which is further classified into depreciable property and non-depreciable property.
- Reverse exchange: It enables the trader to buy replacement property before disposing off the initial property. The reason could be varied, such as for the maintenance work of replacement property, etc.
Delayed 1031 exchange process
The Delayed exchange allows the involved businesses or individuals to relinquish the initial property and buy the replacement property on different dates. Hence, the exchange needs not to take place on the same date, unlike the simultaneous 1031 exchange. It is also often referred to as “Starker Exchange”, “Deferred Exchange”, or “Like Kind Exchange”. The maximum permissible 1031 exchange timeline set by the Code and Regulations to complete the property transfer formalities is 180 days. However, it is important to identify the replacement property 45 days of the transfer of the relinquished property.
The delayed 1031 exchange process is a preferred alternative for traders who find it hard to perform 1031 exchange in real estate under simultaneous exchange, the reason being an extended period for transaction. It requires the interference of a third party that could help in all the involved aspects of property exchange including the sale and purchase of the property under consideration. In addition, the exchange firms also hold the proceeds from the relinquished property to use it later for buying the replacement property.
Three Types of Delayed 1031 exchange
As notified in the code, the traders can identify more than one potential replacement property in delayed exchange under any of the following 1031 exchange rules:
- Delayed exchange under the Three-Property Rule: This allows identifying three properties irrespective of their current market values.
- Delayed exchange under the 200% Rule: This is one of the three 1031 exchange rules and allows identifying as many properties as possible on the condition that their combined fair market value remains less than double the value of the relinquished property.
- Delayed exchange under the 95% Rule: This allows the identification of any number of potential replacement properties irrespective of their combined fair market value, on the condition that the trader acquires 95 percent or more of the aggregate value of the relinquished property.
How delayed 1031 delayed exchange work?
The steps related to 1031 exchange requirements are as below
- Property purchase and sale contract: The agreement should include a “cooperation clause” that asks the buyer to cooperate in the structuring of the transaction as a delayed or tax-deferred exchange. The third party facilitator plays an important part in converting this “sale” transaction into a 1031 exchange, using specific documents.
- Documents for relinquished property exchange: Once done with the contract, the traders need to initiate the 1031 exchange process with the help of a 1031 exchange real estate or a 1031 exchange commercial real estate provider, as the case may be. The approached agency could assist better in preparing various important documents related to 1031 exchange of properties.
- Closing the relinquished property: After the completion of documentation work, the relinquished property is conveyed to the buyer.
- Relinquished property proceeds and forms: The intermediate exchange firm holds the proceeds from the relinquished property exchange and asks the seller to identify potential replacement properties within 45 days.
- Property purchase and replacement contract: The trader identifies like-kind replacement property and signs a purchase contract with its owner. The contract should contain a cooperation clause
- Documents for replacement property exchange: The 1031 exchange firm then prepares the requisite documents to fulfill the 1031 exchange requirements, which must be signed before the closing date.
- Closing the replacement property: The closing should take place within the allowed 1031 exchange timeline of 180 days.
Summary: The delayed 1031 exchange of properties enables the businesses and individuals defer tax payment. Approaching a reputed 1031 exchange firm is advisable as they inform you of various delayed exchange types, suggest the preferred one, and assist in the 1031 exchange process.