1031 Wealth

Replacement property must be “identified” within forty-five (45) days of the transfer of the relinquished property. This is called “the identification period”.

Replacement property must be received by the taxpayer not later than 180 days (including extensions) after the transfer of the relinquished property. This is the “the exchange period”.

If the replacement property is to close after October 17 (except for leap years) you may wish to file for an extension to protect the “exchange period” timing.

To qualify as replacement property, a property must be “identified”. A property is considered to have been identified if it has been designated as replacement property in a written document signed by the taxpayer (exchanger) a delivered by any means to:

Parties to whom a document identifying a replacement property may be directed are: an intermediary, an escrow agent and a title company. We feel the intermediary is the preferred addressee.

Replacement property must be “unambiguously” described. If it is described by a street address, a legal description or a distinguishable name, it is generally unambiguously described. If the replacement property is “identified” in the exchange agreement, which is signed by the parties to the exchange prior to the end of the 45 day identification period, it is considered to have been identified.

If more than three properties are identified (a violation of the “3 property” rule), the sum of the market values of the replacement properties that have been identified may not exceed 200% of the market value of the relinquished property or properties at the time of the transfer of the relinquished properties.

If the taxpayer has violated both the “3 property rule” (by identifying more than three properties) and the “200% rule” (by identifying properties the market value of which exceeds the sales price of the relinquished property by more than 200%) then the taxpayer will be treated as though no properties had been identified. This last sentence will not apply however for any property identified and received by the taxpayer prior to the expiration of the identification period. If the taxpayer receives not less than 95% of the identified properties not later than the end of the 180 day exchange period the previous sentence will also be disregarded.

In the case of most taxpayers, the receipt of income incurs a tax liability for that income. It is also true even though the income has not yet been received by the taxpayer, it is “constructively” received if it is available or could be available at any time during the tax year. Constructive receipt of available income is defeated if there are substantial limitations or restrictions to its control by the taxpayer. Constructive receipt has always been the scourge of tax deferred exchanges under Section 1031 of the Internal Revenue Code because the equity represented by the relinquished property could always be reduced to money. If the Service could convince the judge that the equity was available to the taxpayer, there would be no exchange because one is not permitted to exchange real estate for money. The 1991 regulations made it much easier on the taxpayer seeking to replace his relinquished property with other property by offering three “safe harbors” the use of which would defeat the attempts by the Service to invoke the “doctrine of constructive receipt”.

A disqualified person is anyone who has acted as the agent of the taxpayer at the time of the transaction. For this purpose a person who has acted as the taxpayer’s employee, attorney, accountant, investment banker, stock broker, real estate agent or broker within the two year period ending on the date of the transfer of the first of the relinquished properties to be transferred is treated as the agent of the taxpayer and thus is a disqualified person.

The following services will not be taken into account for the purposes of the above paragraph: routine services with respect to the exchange of property intended to qualify for non-recognition of gain or loss under Section 1031 as well as routine financial, title insurance, escrow or trust services.

An intermediary is one of the “safe harbors” permitted by the Regulations allowing a taxpayer to avoid the doctrine of constructive receipt. An intermediary is an entity, which is not the taxpayer, nor a disqualified person, which, for a fee, enters into an agreement to exchange real property with the taxpayer.

The exchange agreement must expressly limit the taxpayer’s rights to receive, pledge, borrow or otherwise obtain benefits of money or other property held by the intermediary. The agreement must also require that the intermediary acquire the relinquished property from the taxpayer and transfer it to the buyer and acquire the replacement property from the seller and transfer it to the exchanger.

The intermediary is treated as though it has acquired the properties in question if the intermediary enters into an agreement with a person other than the taxpayer for the transfer of properties (The buyer of the relinquished property and the seller of the replacement property) and those properties are actually transferred.

The intermediary is treated as those an agreement had been entered into if the agreement between the parties (the purchase and sale agreements between the exchanger and both the buyer and the seller) is assigned to the intermediary and all parties to those agreements are notified in writing of the assignment prior to the date of the transfer of the relevant property. As a safe harbor First Nationwide Exchange comply with all the above requirements.

Like-Kind refers to the nature or character of the property and not in grade or quality. The fact that real estate may be improved or unimproved is not material. Thus, under Section 1031, any real estate may be exchanged for any other real estate, provided the real estate is neither the taxpayer’s primary or secondary residence, nor is dealer property. Leaseholds with more than thirty years remaining before termination are considered like-kind with fee simple real estate. State laws determine whether an asset is real estate.

Any identification of replacement property may be “revoked” by the taxpayer at any time during the identification period. A revocation must be in a written document, signed by the taxpayer and sent by any means to the person to whom the identification was sent. Revocation of one or more identified properties permits the identification of an equal number of new properties.