STEPS OF A DEFERRED ExchangeTRANSACTION 

This article is meant as an overview explaining the necessary steps involved that are needed when implementing a deferred Exchangetransaction. 

The primary benefit of a real estate Exchangereferred to today, as a Deferred Exchangebased on the Exchangeregulations, is to defer federal and in most cases state income tax, that would be associated with the gain (profit) when disposing of income-producing (business) or investment-held properties. The first step in a deferred Exchangeis to find a buyer, just like if your transaction were to be treated as a sale. You do not need to find someone who owns a property to Exchangeor swap with. 

The structure of a deferred Exchangetransaction is that you as the Taxpayer, (the individual disposing) will transfer title in the Relinquished Property to the professional Qualified Intermediary in Exchangefor the qualified intermediaries promise to acquire and convey to the taxpayer, at the taxpayer's direction other like-kind property known as the Replacement Property. The qualified intermediary‚ will utilize the net proceeds received on the disposition from the Buyer of the Relinquished Property, after adjustment to purchase the Replacement Property. Pursuant to the ExchangeAgreement the taxpayer assigns to the qualified intermediary‚ the rights under the Contract of Sale to dispose the Relinquished Property. For convenience purposes and to avoid additional payment of double transfer taxes, the taxpayer and the qualified intermediary agree to have the Relinquished Property deeded directly from the taxpayer to the purchaser.

This arrangement with the qualified intermediary is intended to comply with requirements for a Deferred Exchangeunder the provisions of Internal Revenue Code Section 1031. The reason for the professional qualified intermediary's‚ involvement is to provide services of a "Qualified Intermediary" party to the Exchangetransaction who is not deemed the taxpayer's agent (known as a "Disqualified Person") for tax purposes. That means, that anyone providing services at the time of the transaction or within a twenty-four month period in the past cannot provide services as a qualified intermediary. That includes the taxpayer's attorney, accountant/C.P.A., real estate agent/broker, mortgage banker/broker, employee, family-member or anyone else who has or had an "agency" relationship with the taxpayer. The professional qualified intermediary should have special training in this area and should be experienced in providing these services. Since the receipt of proceeds, (actual or constructive) from the disposition of the Relinquished Property by the taxpayer, or the taxpayer's agent, would invalidate the attempted Exchangetransaction.

Internal Revenue Code Section 1031 provides two specific time restrictions, which if not met, will disqualify a deferred Exchangefor non recognition treatment. The first is that the Replacement Property to be acquired must be identified within 45 days (“Identification Period”) after the taxpayer transfers the Relinquished Property. The second is that all Replacement Properties which the taxpayer will acquire must be transferred to the taxpayer, no later than the earlier of (i) 180 days (“ExchangePeriod”) after the date the taxpayer disposes of the Relinquished Property (including, in said computation, both the day of disposition of the Relinquished Property and the day of acquisition of the Replacement Property), or (ii) the due date (with extensions) of your federal income tax return. These deadlines are both absolute; i.e. you are not entitled to any extensions of the deadlines under any circumstances. Treasury Regulations Section 1.1031(k)-1 (the "Deferred ExchangeRegulations") sets forth additional rules which govern deferred Exchangetransactions. The Regulations make clear that identification should be made to the Taxpayer's Exchangepartner (the Qualified Intermediary). No official form of identification has been created, but the qualified intermediary should provide an identification form, which the taxpayer should complete and return, designating the Replacement Property or Properties the taxpayer wishes to acquire. This form must be returned and completed within the 45 day “Identification Period”, because failure to timely identify the Replacement Property will disqualify the Exchangetransaction for tax-deferred treatment. The Deferred ExchangeRegulations provide two basic options relating to the number of alternative properties, which may be identified as potential Replacement Properties. You may identify three alternatives (of any value), known as the “3 Property Rule”, without regard to which of the three you intend to acquire. If you identify more than three (3) properties, then you must limit the total value of all identified properties to 200% of the value of the Relinquished Property known as the “200% Rule”. Failure to restrict yourself to one of these two options may mean your entire Exchangeis invalid, since if you exceed these limits you would have to acquire virtually 95% of the total value you identified known as the “95% Rule”. However, you are permitted to make changes in the identification of properties by revoking in writing to the "Qualified Intermediary" and substituting in writing others, during the 45 day “Identification Period” so long as you satisfy the applicable limits at the end of the period. Because of the critical importance of proper, timely identification of Replacement Property, the taxpayer must be sure to understand these requirements and pay particular attention to keeping records of properties identified.

When the taxpayer has located and negotiated an acquisition agreement (Purchase Agreement) for the Replacement Property, the qualified intermediary will prepare an Assignment Agreement. The execution of this Assignment will assign the Taxpayers purchase rights to the qualified intermediary, which will then complete the purchase, using funds up to the total available "Acquisition Credit" in the Qualified Escrow Account". In the event that Acquisition Credit is not sufficient to acquire the designated Replacement Property then the taxpayer will need to add the necessary amount of cash (or finance the difference) to close that transaction. The qualified intermediary‚ will transfer the Replacement Property to the taxpayer again, for convenience purposes and to avoid double transfer taxes, the qualified intermediary‚ may arrange for the Replacement Property to directly deed to the taxpayer from the sellers thereof.  As in all Exchangetransactions it is important to consult a professional qualified intermediary before implementing.