Internal Revenue Code Section 1031 allows investors, in certain cases, to defer the payment of capital gains taxes when selling investment property. Investors unfamiliar with 1031 Exchange rules can sometimes get intimidated by the process. Here we’ll lay it out for you step-by-step. In order to successfully complete an exchange, investors simply need to follow this process.

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1. Set up an Exchange Account with a Qualified Intermediary

Above all else, you need to start with a Qualified Intermediary (“QI”), also known as an exchange accommodator. Our firm–1031 Capital Solutions–can refer you to an experienced QI. A 1031 Exchange account MUST be opened before the close of escrow on the property being sold. Waiting until the very last minute is not recommended, but most QIs can open a ‘rush’ account if necessary, reimbursed thru escrow at the closing of the replacement property.

 

2. Add 1031 Exchange Language

The appropriate 1031 language should be added to the Purchase & Sales contract for the property being sold. Your QI can provide you with such language if necessary.

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3. Execute "Phase 1" Exchange Agreement - Your Sale

At the close of escrow, your QI will coordinate with the escrow company to obtain all necessary signatures on all exchange documents.

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4. Identify Your Replacement Property

The IRS requires that you identify potential replacement property(ies) on or before day 45 of the exchange; you must acquire (close escrow on) the replacement property on or before day 180 of the exchange.

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5. Submit 45 Day Identification Letter

The identification letter (describing your intended replacement property(ies)) MUST be submitted no later than day 45 of the exchange. All potential replacement properties must be identified in writing in an unambiguous manner (your QI can help you with this rule).

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6. Provide Your QI With Your Purchase Contract & Other Information

Once you are under contract with a replacement property, your QI will need to prepare the “Phase 2” 1031 Exchange documents. Your QI will need a copy of the contract and the contact information for the escrow officer.

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7. Request Funds

Funds for the initial earnest money deposit can be made “out of pocket”, but should be disbursed from the exchange account.

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8. Execute "Phase 2" Exchange Agreement - Your Purchase

Your QI will work with the replacement property escrow company to obtain all appropriate signatures for all exchange documentation. Depending on the nature of the transaction, additional steps may need to take place. A good QI will work closely with you to ensure a smooth and successful transaction.

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9. Report the Exchange

Report the exchange for the year your Relinquished Property sold.

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