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Four Essential Requirements for a Tax-Deferred Exchange

1. Like-Kind requirements

Both the property sold (called the "Relinquished Property") and the property bought (called the "Replacement Property") must be "Like-Kind".

  • Real estate is "Like-Kind" to other real estate, but not to capital equipment or other non-real estate assets. A real estate leasehold estate with a remaining term of at least 30 years is "Like-Kind" to other real estate.
  • Exchanges of non-real estate assets, such as equipment used in oil drilling, manufacturing or radio and tv stations, construction cranes, FCC Licenses, software, aircraft, aircraft engines, and other capital assets used in a trade or business, have a more stringent "Like-Kind" test.
  • Certain properties are, by definition, not eligible for 1031 tax deferral treatment; these include partnership (or LLC) membership interests, stocks and bonds, and other intangible personal property rights.

2. Qualified use Requirement

The Relinquished Property must have been held, and the Taxpayer must intend to hold the Replacement Property, for investment or use in trade or business.

  • Replacement Property that is converted to "personal" use, or is otherwise disposed of, soon after being acquired may not meet this requirement.

3. 45 day/180 day Requirement

Within 45 days after "sale" of the Relinquished Property, Taxpayer must have "identified" Replacement Property(ies), and within 180 days after "sale", Taxpayer must have acquired Replacement Property(ies).

  • There are 3 alternative rules for "identification": The 3 property rule, the 200% rule, or the 95% rule.

4. Exchange Requirement

There must be an "Exchange"; a sale of Relinquished Property, where Taxpayer receives (or has the right to receive) sale proceeds, followed by a purchase of Replacement Property will not qualify.

  • During the time period between sale of Relinquished Property and acquisition of Replacement Property, Taxpayer may not have actual or constructive receipt of the sale proceeds.
  • This requirement is met by having a "Qualified Intermediary" document the exchange transaction, hold the taxpayer's sale proceeds, and use proceeds to acquire Replacement Property.

Nine Steps to a Successful Tax-Deferred Exchange

  1. Taxpayer enters into a contract with buyer to sell "Relinquished Property".
  2. Taxpayer notifies a Qualified Intermediary of pending sale.
  3. The Qualified Intermediary is notified of the sale of Relinquished Property, and prepares an Exchange Agreement between the Qualified Intermediary and Taxpayer, and instructions to escrow/settlement agent.
  4. Pursuant to Exchange Agreement, Taxpayer transfers Relinquished Property to buyer, and escrow agent disburses net proceeds from sale to the Qualified Intermediary.
  5. Within 45 days from transfer of Relinquished Property, Taxpayer identifies alternative "Replacement Property(ies)".
  6. Taxpayer signs contract(s) to purchase "Replacement Property(ies)" from Seller(s).
  7. Taxpayer assigns Replacement Property contract(s) to the Qualified Intermediary.
  8. Within 180 days from transfer of Relinquished Property, the Qualified Intermediary purchases Replacement Property(ies) using net exchange proceeds, with legal title transferred from seller directly to Taxpayer.
  9. At end of 180 days period, the Qualified Intermediary sends Taxpayer all earned interest and any remaining net proceeds.

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