1031 Exchange Requirements

By: Josh Riverside

In a 1031 Exchange, the primary requirement is meticulous planning on the part of the exchanger. The preparedness involves talking to the accountant, attorney, broker, lender and a Qualified Intermediary, the legally mandated middle-man who carries out the exchange process until completion.

First of all, the Exchanger has to be sure that the relinquished property he owned had been in use for investment or productive purposes in trade or business, and the replacement property he is going to acquire would also be in use for similar purposes.

The main beneficiaries of this facility are taxpayers within the United States who want to literally "carry " their investment properties while relocating. Thus, the Exchanger may live in Los Angeles and wants to relocate to Montana, and the exchange helps him in acquiring similar property in Montana, relinquishing the property he was holding in Los Angeles.

However, exchange properties outside the USA have been nullified, after the Revenue Reconciliation Act of 1989 and subsequent amendment to IRC 1031, which made real property in the United States and real property outside as "not of like-kind" and hence unfit for exchange.

In enduring this exchange process, the taxpayer must be willing to conform to the tight deadlines, such as the Identification Period and Exchange Period. Failure to comply with them will throw the exchange haywire.

The main deadlines to be met are-the 45-day Identification Period, given to identify the replacement property from the date of transfer of the relinquished property, and the 180-day Exchange period, from the date of transfer of the first property.

In the matter of replacement property, the rule and implications of "like-kind" have to be borne in mind. Also, the knowledge that selling and investing the proceeds in a property one already owns does not translate into exchange at all. Funds applied to property already owned are only purchase of "goods and services," and not exchange of "like-kind" property.

Since the exchanger's legal relationship with the relinquished property is very important, one should not try to dissolve partnerships or change the manner of title-holding during the exchange process.

The principal requirements for complete tax deferral in the 1031 Exchange involve ensuring that proceeds from relinquished property are invested in purchasing the replacement property. The second is to make sure that the debt on replacement property is equal to or greater than the debt on the relinquished property.

For smooth sailing, it is advisable to identify the replacement property beforehand and then proceed to locate a suitable buyer for the property to be relinquished.

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