EIGHTS STEPS TO COMPLETE A SUCCESSFUL IRC 1031 EXCHANGE
1. PROFESSIONAL HELP
Most investors need assistance to accomplish an exchange. Since perhaps tens of thousands to hundreds of thousands of tax dollars may be saved, diligence should be used in locating professionals to get the job done right.
#1 Employ an agent who:
a. Understands how to help you make a direct exchange or
b. Can find a buyer for your property and set up the appropriate structure for the exchange
c. Is located near you. Your proximity to your agent is more important than the agent's proximity to the properties.
#2 Locate real estate oriented legal and tax counsel to review the transaction along the way.
CAVEAT: There are many more people who don't know what they're doing in an exchange than there are who do. Less than 1% of real estate agents are familiar with exchanging. If the real estate agent you have used in the past is not knowledgeable in exchanging, then employ an experienced exchangor on an hourly consulting basis to structure and monitor the transaction from beginning to end. The consultant need not have proximity to the properties involved in the exchange.
2. FIND A BUYER
Let's assume you, the investor, have a salable property. Locate a qualified buyer who is ready, willing and able to buy your property, preferably for all cash. Why? Because your purchasing power will be strongest when shopping with cash. Be sure your buyer agrees to cooperate and participate in an IRC 1031 exchange. The buyer should incur no additional expense nor should you require them to go through title to any property other than the property they are acquiring.
If the market requires you to carry part of the financing, then negotiate the strongest terms possible on the carryback note, i.e. high interest rate, short term, high payments. Make it attractive for the seller of the replacement property you will acquire (the seller will end up accepting the note). If properly structured, the transaction can be exchange for you and an installment sale for the seller of your replacement property.
DO NOT OPEN AN ESCROW. The purchase agreement is a sufficient contract until you locate your replacement property. Premature opening of escrow usually results in escrow instructions which are improperly drawn and will not accomplish your exchange. Most would-be exchanges become flawed at this point. A transfer eventually occurs, but if audited may be deemed a sale and repurchase, not a tax deferred exchange.
Have your buyer remove all contingencies as soon as possible and agree to close upon 30 days written notice from you. Your objective should be to achieve a concurrent closing on all properties involved to avoid the possibility of blackmail from unscrupulous parties who may take advantage of your time constraints. A concurrent closing also avoids the extra expense and other risks inherent in a delayed exchange.
Negotiate as long a time period before closing as possible with the buyer of your property. Six months is desirable, but 90 to 120 days is usually workable. During this time you will be looking for a replacement property.
6. FINDING YOUR REPLACEMENT PROPERTY
This may be the most difficult challenge you will face. Locating an investment property that makes economic sense is like searching through a junk pile. You can become frustrated sifting through incomplete, inaccurate and unrealistic income and expense projections (most are just that - projections). If you work with an agent, you should employ that agent in writing as a Buyer's Broker to represent only you. He/she will help you locate a suitable property. As your representative, he/she will help you separate fact from fiction and negotiate the best deal on a property, one that meets your economic objectives and that you will feel comfortable owning. Employing the agent to represent YOU as opposed to the seller should increase the number of properties you are exposed to. Buyer's Brokers are not limited to listed properties only.
7. THE OFFER ON YOUR REPLACEMENT PROPERTY
This should require the seller to cooperate in your exchange and should be subject to closing on relinquishment of your original property in the same transaction. Once you have removed any contingencies on the acquisition of your replacement property, you are now ready to open a "pot exchange escrow." All acquisitions and dispositions should be handled in this one escrow.
A properly drawn "pot escrow" can accommodate more than one participant who desires a tax deferred exchange. It is superb in situations where an investor acquires several properties concurrently from unrelated sellers. It is less expensive than a delayed exchange. Direct deeding is safer. Why go through sequential deeding of title to property on which you may incur liability? A buyer's disposition of cash can be specifically directed to avoid the "constructive receipt" problem for the investor who wants to defer taxes. Very few escrow officers or attorneys know how to set up a pot escrow properly. To achieve a tax deferred exchange requires more than just INTENT.
THERE MUST BE A RECIPROCAL TRANSFER OF PROPERTIES.
An exchange must take place. This fundamental principle is often ignored, resulting in many improperly structured transactions. Admittedly, paperwork was sloppy in a few major exchange cases where the taxpayer prevailed. However, your exchange should be so important to you that you will require the proper format and documentation.
Since IRS codification of the delayed exchange, many agents with no training or experience became involved, believing that when you use an intermediary, tax deferred exchanges are now simple. If anything, the new rules have added an additional level of COMPLEXITY and RISK to the specialty field of exchanging. An investor needs guidance through the real estate "jungle" not more than ever before. Your guide in the exchange process should be a real estate agent with specialized training and experience in exchanging. He or she can be employed either for full brokerage services or on an hourly or flat fee consulting basis. An escrow officer with experience in exchanges is an important member of the team. Other participants in the team effort are the real estate oriented CPA and a knowledgeable attorney. To repeat, where tens to hundreds of thousands of tax dollars may be saved, it is critical that the job be done right to benefit and protect the investor.
Deborah Hoyt is a Real Estate Broker and co-owner of Hoyt & Hufford Real Estate in
For more details on 1031 Exchanges contact:
DEBORAH HOYT or CLINT HUFFORD