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Types of Exchanges

Depending upon your circumstances, there are several ways to complete an IRC compliant 1031 exchange

  • Simultaneous

    Prior to Congress modifying the Internal Revenue Code and formally approving the concept of delayed exchanging, virtually all exchanges were of the simultaneous type. To qualify as a simultaneous exchange, both the relinquished property and the replacement property must close and record on the same day.

  • Deferred

    Generally, when one discusses exchanges, the type of exchange referred to is the delayed, deferred or Starker exchange. This term comes from the name of the Exchanger who was first challenged for a delayed exchange by the IRS. From this tax court conflict came the code change in 1984 that formally recognized the delayed exchange for the first time. This is now the most common type of exchange.
    In a delayed exchange, the Relinquished Property is sold at Time 1, and after a delay of up to 180 days, the Replacement Property is acquired at Time 2.

  • Reverse

    The reverse exchange represents an exchange in which the Exchanger locates a Replacement Property and wants to acquire it before the actual closing of the Relinquished Property. Since the Exchanger cannot purchase the Replacement and later exchange into property that he already owns, he must find a method to acquire the Replacement Property and still maintain the integrity of the exchange.

    The most common reverse exchange approach is for the Exchanger to arrange the acquisition of the Replacement Property by adding enough cash (or arranging suitable financing) to buy the new property. The title for the new property is then held by an Exchange Accommodation Titleholder (an LLC created by the Qualified Intermediary). The EAT holds title to the Replacement property until such a time within the 180 day exchange period that the Relinquished Property is sold. At that time either the Replacement Property is deeded to the Exchanger by the EAT, or the EAT itself is transferred to the Exchanger.

  • Improvement

    In some cases, the replacement property requires new construction or significant improvements to be completed in order to make it viable for the specific purpose the Exchanger has intended for the property. Such construction or improvements can be accomplished as part of the exchange process, with payments to contractors and other suppliers being made by the Qualified Intermediary or Facilitator out of funds held in a trust account. Therefore, if the replacement property is of lesser value than the relinquished property at the time of the original transaction, the improvement or construction costs can bring the value of the replacement property up to an exchange level or value which would allow the transaction to remain completely tax deferred. Most improvement or construction exchanges utilize an Exchange Accommodation Titleholder to hold the title to the property while the improvements are completed. This avoids a situation where the Exchanger is exchanging into property he already owns.

Four Steps to Exchanging

Plan your transaction and setup your exchange with a Qualified intermediary

Every 1031 exchange deserves to be planned beforehand. With the limited time constraints and the logistical difficulties associated with closing multiple properties, spending a short time laying out the objectives will allow an Exchanger to minimize obstacles and create suitable contingencies.

Locate and Identify Replacement Property within 45 days

The most difficult part of any 1031 exchange is locating and identifying candidate or target replacement proeprties within the brief 45 day identification period. The Exchanger is also required to identify using the three property rule, the 200 percent rule, or the 95 percent exception.

Complete the Replacement Property purchases within 180 days

The other critical time related rule is that all the replacement proeprties must be acquired and closed within 180 days or whenever your tax return is due. This means if it is late in the year, you may need to file an extension of your tax return in order to have access to all 180 days.

Report the 1031 Exchange on Form 8824 with your tax return

The Internal Revenue Service views the taxpayer's use of Section 1031 as a method for moving the cost basis from one qualifying property to another. Therefore your exchange must be reported to the IRS on Form 8824 with your tax return for the year in which the exchange was started.

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Types of Investment Grade Property

Delaware Statutory Trusts

Delaware Statutory Trusts or DSTs are organized investment structures which allow individual investors to own fractional interests in larger, investment grade properties. DST property portfolios are professionally managed and sold as securities to Accredited Investors only. DST investors receive their share of the property rents monthly rents as well as their ratale percentage of tax benefits. DST interests are considered like-kind properties for the purposes of IRC Section 1031 and therefore qualify as suitable replacement proeprty in a 1031 exchange.

Net Leased Properties

Net lease refers to the contractual arrangement between the owner of a property and the lessee where the lessee pays a portion or all of the taxes, insurance and maintenance costs for a given property in addition to their rent.
Net Lease: tenant pays one of the three expense categories. Net Net Lease: tenant pays two of the three expense categories.
Net Net Net (TripleNet) Lease: tenant pays all three expense categories. Triple net leases usually include an entire building and are written for longer periods of time than the other two categories.

Tenant in Common

Tenancy in Common is a specific type of concurrent, or simultaneous, ownership of real property by two or more parties. This means that each owner can own an undivided interest in a property and receive their ratable share of the income and tax benefits. This is a common method for owning investment properties. This also means that each owner has the right to sell their ownership interest.
Because a TIC interest represents an interest in the underlying property, it can be exchanged pursuant to Section 1031 of the Internal Revenue Code.

Easy 1031 Exchange Math

A completed 1031 exchange not only defers capital gain and depreciation recapture taxes, it dramatically increases your buying power as well. The IRS allows you to defer your capital gain taxes because they view it as simply moving your costs basis from one qualifying property to another.

DETERMINING YOUR REPLACEMENT VALUE

It is important to understand how the underlying math can impact the value of your Replacement Property. For instance, this nearby wizard will help you determine your ideal net purchase price, cash downpayment and the amount of debt you'll need to have a toally tax deferred transaction.


1031 Educational Materials

This comprehensive guide to 1031 exchanging will cover everything you need to know to be an informed Exchanger.

If you just have a question or two check out this FAQ and you'll probably find the answer to your inquiry.

There are a handful of keys to 1031 exchanging which experienced Exchangers always heed. See them for yourself.

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