Velocity of your money (continued)

you want the transaction to be 100 percent tax deferred. A rule of thumb to defer taxes is to always replace the exchange property with one of equal or greater value and debt. You should bring cash to the closing of the exchange property to cover charges that are not transaction costs, such as utility escrows, rent prorations, etc. An exchange intermediary must be used to hold the exchange funds from the closing of the old property.

The exchange intermediary

In the typical exchange, you will be selling a property which you have been holding for investment. According to the IRS rules you cannot touch the money that comes from the closing of your former property. You need to hire an exchange intermediary. The intermediary will charge a fee for completing the exchange agreement and all the necessary paperwork. The intermediary will hold your cash proceeds until you are ready to close on the replacement investment property.

The exchange agreement

The agreement between the investor and the exchange intermediary contains an assignment of the contract to the intermediary. It allows the intermediary to hold the funds until the next closing. If the investor was to take receipt of the funds, a taxable event would occur. The deadlines for the identification and closing of property will be specified. It will allow the intermediary to disburse exchange funds to purchase the replacement property.

The reverse exchange

The IRS also allows for what is known as a reverse exchange. In this case, the replacement property is purchased, through the Intermediary, prior to the old property being sold. The Intermediary actually takes title to the property and holds it until the investor can find a buyer for the old property. After the replacement property is purchased, the investor has 45 days to identify the property that will be relinquished, and

180 days from the closing of the replacement property, to close on the property being relinquished. The reverse exchange creates some financing issues since lenders don’t like to lend money to the intermediary. Therefore, the investor typically needs to have the cash available to purchase the replacement property, or have a line of credit arranged.

Simultaneous exchange

This is an exchange when the relinquished property and the replacement property closings both occur on the same day. An exchange like this is excellent, if you can get real estate owners lined up who will literally exchange their property at the same time. Most exchanges are accomplished using the delayed exchange rules.

Delayed exchange

This is the typical exchange in which the taxpayer has 45 days after closing the relinquished property to identify the replacement property and

180 days to get it closed.

Improvement exchange

This is an exchange in which the taxpayer needs to enhance the property to create adequate value to close the exchange without creating a tax liability. The improvements need to be done before the 180 days have passed.

Learn more

This article was just a brief overview of the 1031 exchange concept. There are many other details and intricacies to learn about. It’s advisable to consult with your tax professional and your 1031 intermediary company to determine what works best for you.

Duane has been a Realtor since 1982. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail DuaneDuggan@boulderco.com, call 303.441.5611 or visit boulderco.com.

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