Key Exchange Requirements | Appropriate Documentation | Problem Spotting | Setting the Exchange Process In Motion

 

In order to comply with exchange requirements, four key factors must be met. In talking with clients, be aware of the following:

1) Both the property to be transferred and the property to be acquired must be held for rental or investment purposes or use in a trade or business.

2) To defer 100% of the tax on the gain, exchanger must

a) Trade equal or up in fair market value

b) Reinvest all of the equity the exchanger had in the old property

c) Generally, have equal or greater debt on the new property as he had on the old property.

3) Title must generally be held the same way in the new property as it was held in the old property.

4) An exchange agreement with a qualified intermediary must be in place by closing of the relinquished property.

Proper documentation is one of the critical aspects of an exchange. As the qualified intermediary, ITEC will provide draft copies of the Exchange Agreement and related documents for review by the exchanger's counsel. The first important step, however, is inclusion of language in the sales contract at the time the Exchanger accepts an offer to purchase his old property. Suggested language to be inserted in the sales contracts follows:

Relinquished Property Contract Language:

The Seller expressly reserves the right to assign its rights under this agreement to Investors Title Exchange Corporation as Qualified Intermediary, for the purpose of effecting an IRC Section 1031 tax-deferred exchange. The Buyer hereby acknowledges Seller's right to assign this contract, and agrees to cooperate with the Seller in a manner necessary to complete the exchange which will not delay the closing or cause additional expense to the Buyer.

 

Replacement Property Contract Language:

The Buyer expressly reserves the right to assign its rights under this agreement to Investors Title Exchange Corporation as Qualified Intermediary, for the purpose of effecting an IRC Section 1031 tax-deferred exchange. The Seller hereby acknowledges Buyer's right to assign this contract, and agrees to cooperate with the Buyer in a manner necessary to complete the exchange which will not delay the closing or cause additional expense to the Seller.  

A number of common real estate issues can have a potentially negative impact on any tax-deferred exchange. You can assist your client by watching for these red flags and bringing them to the attention of the qualified intermediary or the client's counsel. In addition to the four core exchange requirements listed above, look for the following:

1) Is the exchanger considering seller financing?

2) Does the exchanger want to sell to or buy from a related party?

3) Does the exchanger want to build the replacement property?

4) Does the exchanger want to buy replacement property before closing on the sale of the relinquished property?

5) If the property is owned by a partnership, do only some of the partners want to do an exchange?

This is not an exhaustive list of potential pitfalls, but serves as an illustration of the complexity of the exchange rules and the need for competent exchange counsel.

Once your client has decided to plan an exchange, to assist your client:

1. Contact ITEC to serve as qualified intermediary. ITEC will prepare the exchange documents and coordinate the exchange transaction with the settlement agent and the exchanger's counsel before the first closing.

2. Make sure the sales contract for the relinquished property contains the exchange clause.

3. Help the exchanger begin looking for replacement property. Replacement property must be formally identified within 45 days after the closing of the relinquished property.

Top

 Print Page