Keep your focus on the rules and guidelines of the 1031 exchange and make sure you are following them closely. While most exchanges have an element of complexity following the basics will help your exchange be successful.

The outline of the basics of a 1031 Exchange.

Before closing on your relinquished property IRS Regulations require that the exchange documentation be in place prior to the closing on the property being sold/relinquished.  After deciding to structure your real estate sale as a 1031 exchange, the first step is to visit our website at www.directrust1031.co and fill out the START YOUR EXCHANGE box information.  

Then call us at 877-975-1031.  

We will then send you your document package which will include a variety of information for you (your exchange agreement, the qualified escrow agreement, w-9 form and more) and we will ask you return them to us along with a driver’s license or entity confirmation of good standing and deliver it to us/email it to us at exchange@directrust1031.co

Before your closing we will give notice of assignment to the buyer of your relinquished/to be sold property. This assignment will show your intent to do an exchange, assign the contract to the Qualified Intermediary (QI), and to assure the buyer that there is no expense or risk for the buyer. Notice of the assignment must be made in writing to the buyer and all other parties to the contract, including co-sellers, if any. This means that if there are multiple sellers in addition to the taxpayer, they must also receive written notice. We have the form available to give parties proper notice.  

Relinquished Property Addendum 

Once the contract on the property being relinquished/sold has been signed, a copy will be provided to the Qualified Intermediary (or “QI”), along with the contact information of the attorney, and the title company, settlement agent, or escrow agent who will be overseeing the closing. The QI has already prepared and had signed, the exchange agreement, the assignment agreement, the notice of assignment (to the buyer) along with the qualified escrow agreement and will provide this document package to the taxpayer and counsel and provide instructions to the settlement agent. These documents must be signed and delivered prior to the closing (or at least, at the closing).

At closing the settlement agent should be directed by the seller to have their net proceeds sent via wire transfer using the banking and wire instructions provided in the exchange package.  Note: the exchanger should expect to receive a 1099 form, that will later be negated for the IRS form 8842 filing.  If Directrust℠ fee hasn’t been paid, the closing statement should provide for such payment.  If a check is not received Directrust℠ will debit the exchange funds upon receipt of them for the fee amount.  

After Closing The settlement agent should wire funds directly to the QI, and forward copies of the settlement statement and other closing documents to the QI, either electronically or by overnight delivery. 

45-Day Identification The taxpayer has within 45 days after closing on the relinquished property to provide the identification of the potential replacement property/properties to the QI. IRC regulations provide some options for identity: (i) if the replacement property is received before the end of the 45-day identification period, it is considered identified; (ii) identify no more than three alternative properties, regardless of fair market value; (iii) if the taxpayer identifies more than three properties, the total fair market value should not exceed 200% of the value of the property relinquished; (iv) if identifying more than three properties, with total fair market value exceeding 200%, then the taxpayer must actually acquire a minimum of 95% of the identified fair market value.

 IRS code require the identification of replacement property/s be in writing, be signed by the taxpayer, and delivered to the QI. 

Once the identification period has expired, only those properties that were properly identified may be acquired as replacement properties and be part of the exchange.  The identified property may be changed or withdrawn throughout the 45-day identification period and a replacement property may be identified. This should be done in writing, be signed by the taxpayer, and be delivered to the QI before the end of the identification period ends.  

 Identification of Property to Be Built There are specific rules for the identification and receipt of replacement property to be built. The IRC code requires a legal description for the underlying land and as much detail is provided regarding construction of the improvements as is practicable at the time the identification is made.

Note: Improvements to be made to property already owned by the taxpayer are not considered like-kind and cannot be used as a replacement property in a 1031 exchange. 

180-Day Exchange Period The taxpayer must complete the acquisition of the identified property/properties within 180 days from the transfer of the first relinquished property – or the due date of their tax return, whichever date is earlier. Taxpayers who start their 1031 exchanges after October 15 may want to consider filing for an extension on their income taxes to obtain the benefit of the full 180-day exchange period. Obtaining an extension requires filing IRS Form 4868 and provides an extension on the due date of the tax return only, not on the 180-day exchange period. 

Failure to close When a replacement property is identified within the 45-day limit, the only way to terminate the account early is if there occurs a material and substantial contingency that relates to the exchange, is provided for in writing is beyond the control of the taxpayer or any other disqualified person. Else, the funds must remain in the exchange account for the full 180-day exchange period. If the expiration of the 45-day exchange period crosses over into a second tax year without any identification or should the 180-day exchange period cross into a second tax year without any acquisition, the taxpayer can choose to report the gain (i) in the year the sale took place or (ii) the year in which the taxpayer received the distribution from the exchange account.

Before closing on the replacement property When an offer is made on the replacement property, an Addendum may be added, stating that the transaction is part of a like-kind exchange, that the contract may be assigned to the QI, and that there is no additional liability or expense to the sellers. As with the addendum for the relinquished property, this is technically not required.   

Replacement Property Addendum Once the QI receives a copy of the contract to purchase the identified replacement property/s, they (the QI) will prepare the appropriate Assignment of Contract, Notice of Assignment, and instructions to the settlement agent. The QI will coordinate with the taxpayer, taxpayer’s counsel, and the settlement agent, and wire the exchange funds to the settlement agent. The notice of assignment must be made in writing to the seller and all other parties to the contract, including co-buyers, if any. This means that if there are multiple buyers in addition to the taxpayer, they must also receive written notice.

Prior to closing At any time prior to closing on the purchase of the replacement property, the taxpayer, or their attorney, may submit a signed request that available funds be wired (or a check prepared) to the settlement agent in connection with the purchase.

IRS reporting

 IRS Form 8824 As part of the taxpayers return for the year that the relinquished property was sold/closed, the investor will fill out IRS Form 8824 to report the 1031, like-kind exchange. Also, the depository bank where the exchange funds were held in an escrow account will send the taxpayer a 1099 in the amount of interest that accrued on the exchange deposit. This should be reported as income as well on the IRS Form 8824.