Source: https://legal1031.com/1031-basics/basics/faqs/
Timestamp: 2019-04-20 07:05:04+00:00

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Q.1 What is a §1031 Exchange?
In order to structure a transaction as an IRC §1031 tax deferred exchange a taxpayer would follow the steps contained in our Checklist.
Simply put, an exchange is structured as a sale, just like any other sale, and a purchase, just like any other purchase, but with the inclusion of a qualified intermediary to structure the transaction as an exchange. It is very important to involve the qualified intermediary before you start your transaction. Without the involvement of a qualified intermediary before the sale of the relinquished property the proceeds become taxable and any proceeds used to acquire replacement property are with after-tax dollars.
A qualified intermediary may not be a “disqualified person” as further defined in the Treasury Regulations. A disqualified person normally includes, but is not limited to, your attorney, CPA or accountant, realtor, agents, employees, relatives, and entities in which you have an interest. It is important to perform some due diligence when choosing a Qualified Intermediary to structure your transaction. At Legal 1031 Exchange Services, Inc. we pride ourselves on our knowledge, customer services, and security of the 1031 exchange funds held in escrow for our clients.
One of the most misunderstood concepts of tax deferred exchanges is the concept of like kind. Many people wrongly believe that like kind means the same type of property must be purchased when completing an exchange. Nothing can be further from the truth. An Exchangers can sell one type of property and buy a completely different type of property as is explained below.
The relinquished property must be held for productive use in a trade or business, or for investment purposes, and be exchanged for property that is also to be held for productive use in a trade or business, or for investment purposes. IRC 1031(a)(1). However, real property can only be exchanged for real property. Although tax deferred exchanges are a creature of federal statute, it is state law that determines if a property is real. Reg. 1.1031(a)-1(b), (c), Aquilino v. United States, 363 U.S. 509 (1960). Furthermore, like kind only refers to the nature or character of the property, not to its grade or quality. Treas. Reg. 1.1031(a)-1(b).
What this means is that exchangers have the opportunity to purchase replacement property of any type. For example, an exchanger can sell vacant land and buy a strip mall; or sell an apartment building and buy a net leased property. Although §1031 exchanges are governed by federal law it is state law that determines what is and what is not real property. Therefore, exchanges of real estate interests such as air rights, easement, timber, conservation easements, and development rights may be possible. The graphic below illustrates how all property held for business or investment purposes is like kind to all other property held for business or investment purposes.
The Exchanger may change the properties identified as often as it wants during the 45 day identification period by revoking the previously identified properties and then identifying new potential replacement properties. It is essential that the identification is delivered by midnight of the 45th day, or postmarked by the 45th day, to the Exchanger's Qualified Intermediary or to a party related to the exchange who is not a disqualified person. Typically, delivering the identification to the Qualified Intermediary is the safest course of action to prevent disqualification of the transaction for an invalid and/or untimely identification. If the Exchanger fails to deliver the identification in a timely fashion or does not comply with one of the three identification options, the exchange will be disallowed.
1) The Three Property Rule: the "three property" identification rule allows an Exchanger to identify up to three replacement properties. There is no value limitation placed upon the prospective replacement properties and the exchanger can acquire one or more of the three properties as part of the exchange transaction. The "three property" rule is the most commonly used identification option, allowing an exchanger to identify fall back properties in the event the preferred replacement property can not be acquired.
For example, assume an Exchanger identifies ten properties of equal value. In order to satisfy the rule, the Exchanger would be required to acquire all ten identified properties within the exchange period to complete a successful exchange. If one of the properties fell through, the entire 1031 exchange would be disqualified because the exchanger did not acquire 95% of the fair market value identified. This rule should only be utilized in situations where there is a high level of certainty pertaining to the acquisition of the identified properties and the other two rules do not meet the Exchanger's objectives.
Q.5 What is the structure of a delayed exchange?
Tax deferred exchanges are normally structured as one of four variants: simultaneous, delayed [Treas. Reg. 1.1031(k)-1(a)], reverse [Revenue Procedure 2000-37], and build-to-suit. In the case of a simultaneous or delayed exchange, the exchanger first enters into a contract to sell the relinquished property or properties. Contrary to popular belief there is no “exchange contract” for a delayed exchange. The exchanger enters into a contract that they would normally use if they were not structuring the transaction as an exchange. However, the addition of an exchange cooperation clause is recommended to secure the cooperation of the buyer or seller of the relinquished property or replacement property, respectively.
A person or entity that is not a disqualified party [Treas. Reg. 1.1031(k)-1(g)(4)(iii)], usually a Qualified Intermediary, thereafter assigns into the rights, but not the obligations of the contract. This assignment creates the legal fiction that the Qualified Intermediary is actually swapping one property for another. In reality, the exchanger sells the relinquished property and purchases the replacement property from whomever he or she wishes in an arms length transaction. There is absolutely no requirement that an exchanger actually “swap” properties with another party.
In addition to the assignment of contract, there must be an exchange agreement entered into prior to the closing of the first property to be exchanged. The exchange agreement sets forth the rights and responsibilities of the exchanger and the entity acting as a qualified intermediary, and classifies the transactions as an exchange, rather than a sale and subsequent purchase. In addition, the exchange agreement must limit the exchanger’s rights “to receive, pledge, borrow, or otherwise obtain the benefits of money or other property before the end of the exchange period.” Treas. Reg. 1.1031(k)-1(g)(6). That is, the exchanger may only use the exchange funds to purchase new property, and to pay most expenses related to the sale and purchase of the properties.
Q.6 What kind of due diligence should I do when picking out a qualified intermediary?
1. What is the experience of the person who you are speaking with? How long have they been in the industry? How often do they lecture on IRC §1031 tax deferred exchanges? Are they a published author, and were the articles published in a major legal publication such as a law journal? Are they a tax or legal professional such as an attorney or CPA? Remember, the person on the other end of the phone may be from a big company but may only have a few months experience. It is important to ask!
2. Does the Qualified Intermediary segregate the Exchange Funds into separate Qualified Escrow Accounts as provided in the Treasury Regulations or do they co-mingle the Exchange Funds? A Qualified Intermediary that uses internal “memorandum accounts” is not providing you or your client with the maximum protection that the Safe Harbors of the Treasury Regulations allow. Legal 1031 Exchange Services, Inc. only uses segregated accounts and can provide you with deposit verification letters directly from our depository bank.
3. Have you received a copy of the Fidelity Bond and Errors & Omissions coverage before you have started your Exchange? Is the amount of coverage for each transaction greater than the cash proceeds you will be sending? Have you verified that the Fidelity Bond and E&O coverage are in full force and effect? And perhaps most importantly, does the Fidelity Bond provide for principal liability? Many Fidelity Bonds only provide protection from employee malfeasance but leave the Exchanger uninsured in the case of malfeasance of a principal. Remember a Qualified Intermediary will be holding onto your funds or your client’s funds. It is imperative that you do some due diligence.
It goes without saying that service is an extremely important part of an IRC §1031 tax deferred exchange. Exchanges are subject to strict guidelines and requirements. Unless you can receive your exchange documents in a timely fashion and have your exchange proceeds. It is important that you are able to reach the people who have the expertise and have the ability to close your transaction in a timely fashion.

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