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1031 Exchange Requirements, Rules & Steps
If you’ve decided you’d like to execute a 1031 exchange, you’ll need to follow some rules and take the following steps:
1031 EXCHANGE RULES AND 1031 EXCHANGE REQUIREMENTS
Cooperation Clause Agreement
You must have a cooperation clause written into the agreement. This ensures the buyer is aware you intend to enter into a 1031 tax-deferred exchange and can structure the transaction accordingly.
Employ A Qualified Intermediary
You must employ a qualified intermediary (accommodator/facilitator) and they must hold the sale proceeds for the taxpayer during the 1031 exchange, disburse funds for the purchase of the like-kind replacement property and return unused funds to the seller/taxpayer at the end of the exchange.
No Control Over Net Sale Proceeds
You can’t receive or control the net sale proceeds; they must be deposited with a qualified intermediary.
Exchange Like-kind Property
You must exchange like-kind property, which can include commercial, single-family rental property, condominiums, raw land, apartments, vacation homes, duplexes, industrial properties and a leasehold interest of 30-plus years. Note: a primary residence does not qualify for a tax-deferred Section 1031 exchange.
45-day Identification Period
There must be a 45-day identification period which means the exchanger must identify a replacement property within 45 days of the sale of the relinquished property. There are three rules used to specify this property:
- The Three Property Rule
Three replacement properties of any individual or combined value; one or more of these three properties can be purchased as the qualifying replacement property.
- The 200% Rule
You can name as many properties as you’d like as long as the total value of all the properties does not exceed 200% of the sale price of the relinquished property.
- The 95% Rule
You can name as many properties as you’d like regardless of their total value as long as the investor buys at least 95% of the total value of all the properties.
Replacement Property Value
You must ensure the cash invested in the replacement property is equal to or greater than the cash received from the sale of the relinquished property.
Replacement Property Debt
You will need to make certain the debt placed/assumed on the replacement property is equal to or greater than the relieved debt of the relinquished property.
Closing
Closing must occur within 180 days of the closing on the relinquished property (or by your tax return due date, if earlier), or the exchange won’t qualify for Section 1031 treatment.
1031 EXCHANGE STEPS
Step 1
You sell an investment property and enter into a purchase contract that obligates the buyer at no cost to the buyer to cooperate in closing the transaction as a 1031 exchange with the help of a qualified intermediary (QI). Your relinquished property purchase contract should contain a cooperation clause, which obligates the buyer to cooperate with you in structuring the transaction as a 1031 exchange.
Step 2
DIS will assist you in finding a qualified intermediary with whom you’ll open an account to transfer the proceeds from the sale. An accommodator will review the purchase agreement, title report and draft exchange documents to be executed by the exchanger. The exchanger must not take possession of the funds or the exchange will be disqualified.
Step 3
Exchanger of the property identifies replacement properties within 45 days of the sale and notifies the QI by midnight of the 45th day. The escrow agent will need to insert cooperation clause language into your purchase and sale agreement and/or escrow instructions. The escrow agent will advise the QI of the specific replacement property on your identification list you will be acquiring and who will be handling the closing. Your 1031 exchange documents can now be executed, and funds released to escrow.
Step 4
For escrow to close the closing date must occur within 180 days of the closing on the relinquished property (or by your tax return due date, if earlier), or the exchange won’t qualify for Section 1031 tax-deferred treatment.
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