May 25, 2022
Peter
Peter Marzo
So, you have decided to go through with a 1031 exchange to defer costly capital gain and depreciation recapture taxes.  Smart move!!  With that in mind, a 1031 Exchange can be a daunting process which may leave most property owners in confusion.  There are many steps to consider upon selling your property which only seasoned investors or Qualified Intermediaries (QI) may be familiar with.  In this article, we will discuss several steps to take before entering into a 1031 exchange and more importantly, how to successfully complete one.    

The 5 steps to take before your 1031 exchange are:
·         Include QI Before the Close
·         Include Exchange Language in Sales Contract
·         Know the Rules of an Exchange
·         Identify Replacement Properties Early
·         Use a Delaware Statutory Trust (DST) as a Backup

 

Include QI Before the Close

If you feel a 1031 is right for you, it’s essential that you familiarize yourself with the general mechanics of a 1031 exchange.  To facilitate a 1031 exchange, the Qualified Intermediary (QI) aka the 1031 Accommodator must be included in the sales process on the front end before the relinquished property is closed.  The Qualified Intermediary (QI) is an independent entity that acks as the liaison on behalf of the seller and ensures the exchange remains compliant with the rules and regulations of IRC section 1031.    

Think of the Qualified Intermediary (QI) as the glue that holds the buyer and seller together in a 1031 exchange.  Aside from being the heart of the exchange itself, the main function of the QI is to restrict the investor’s access to the sale proceeds upon the sale of the relinquished property and comply with the “safe harbor” rules set out in reg. 1.1031(k)-1(g)(4).  This is done by holding the final sales proceeds of the relinquished property in a qualified escrow account specifically dedicated to holding exchange funds.

At Marzo Capital Group, we work with leading QIs around the country and can refer several reputable accommodators in your local area.  Please reach out to us for a current list of QIs. 

 

Include Exchange Language in Sales Contract

1031 Tax-Deferred Exchange Contract Language refers to the contractual language used in real estate when a taxpayer wishes to sell one property and buy another for investment purposes.  Most newbie exchangers overlook this very important step. 

When it comes to real estate investments, the Internal Revenue Code requires specific language in both purchase and sale agreements establishing an investor's intent to perform an exchange.  This language specifies that an investor intends to sell their investment property and purchase a replacement for investment purposes.  For such an exchange to occur, the contract must express this intention.  This is necessary in order for the exchange to qualify for the IRS. 

Also, the language provides advance notification to the other party that the contract will need to be assigned to an intermediary.  This can typically be done before the contract is drafted or be added to an existing contract through an addendum.  It's important to note if exchange language is excluded from the contract or funds are taken into possession upon closing, the exchange will be terminated. 

 

Know the Rules of an Exchange

There are very specific identification period requirements for a 1031 exchange. If you’ve read our article on how a 1031 exchange works, you know that the identification period has strict deadlines that must be followed. In order to meet those deadlines, it’s important to understand the rules surrounding identifying replacement properties.

45-Day Identification Period

Replacement properties under consideration for acquisition in a 1031 exchange should be identified to the QI and must be identified no later than midnight of the 45th calendar day following the close of the relinquished property sale transaction. 

Like Kind

Other important rules to understand before conducting a 1031 exchange have to do with the types of real estate interests that qualify for an exchange, commonly referred to as “like-kind” properties.  This simply means that the investor must exchange one form of real property for another. This could include transactions like selling an apartment complex to purchase a warehouse or selling a retail center to purchase an office building.

Identification Rules

In addition, 1031 exchange investors must comply with one of the three property identification rules when identifying potential replacement properties. These rules include the Three Property Identification Rule, the 200% of Fair Market Value Identification Rule, and the 95% Identification Exception.

Replacing Equal or Greater Value, Equity and Debt
For the 1031 exchange to work as it is designed, in most cases you’ll want to purchase a property of equal or greater value as the one you are selling. This difference in value is what will allow you to grow your portfolio and “trade up,” which is usually what you are trying to do when using a 1031 exchange.

Trading into a property with a higher value is also what allows the rules surrounding your equity to work correctly. To avoid paying any capital gains tax on the transaction, you must reinvest all the equity from the relinquished property into the new property. If there is equity left over that is not reinvested, that amount will be taxed. 

For futher detail regarding these topics, we encourage your to read our blogs titled How does a 1031 Exchange Work?, What Qualifies as a  “Like-Kind” Property in a 1031 Exchange and What are the Rules of a 1031 Exchange? . 

 

Identify Replacement Properties Early

There is nothing more underestimated in a 1031 exchange then the amount of time you are allotted to identify a replacement property.  The IRS allows an exchanger only 45-days to properly identify a list of replacement properties.  This may seem long, but when attempting to identify, place bids, submit LOIs, negotiate, inspect and coordinate all interested parties, this time passes quickly.  Start looking for replacement properties early, even before you close. This will allow you to take advantage of the 45-day ID period to perform proper due diligence and leave time in the event a property falls through. 

 

Use a Delaware Statutory Trust (DST) as a Backup

When faced with strict timelines to identify suitable replacement properties for an exchange, you owe it to yourself to evaluate a Delaware Statutory Trust (DST) and the many benefits one can offer.  Consider using a Delaware Statutory Trust (DST) as 1031 exchange backup.  This is an excellent strategy to ensure (not guarantee) an investor will successfully close on the properties identified.  Due to the nature of DSTs being pre-financed and pre-closed, this alleviates the many possibilities of a failed exchange due to complications surrounding sellers, lenders, etc.    

The Delaware Statutory Trust can also be a great alternative for landlords looking to delegate property management responsibilities to a 3rd party.  DST properties are managed by the best-in-class property management firms in the country making the DST a solution for passive, turnkey investing. 

DSTs may be suitable if you are a property owner who:

·         No longer wants to actively manage real estate
·         Wants to diversify their investment portfolio
·         Wants to limit personal liability
·         Wants to invest a smaller amount

For a full list of benefits, read 10 Advantages of Owning a Delaware Statutory Trust (DST).

Browse our 1031 exchange approved properties today and be sure to read our free eBook titled “The Power of 1031 Exchanges & Delaware Statutory Trusts (DSTs)”.

 

Conclusion

The IRS has many stringent rules and regulations regarding the 1031 exchange code.  Meeting deadlines can be difficult and can sometimes lead to a failed exchange.  Luckily, investors today have many resources to protect their investments.  Even when faced with a potential failed exchange, there are many options to take advantage of in order to preserve your 1031. 

It is strongly recommended to identify more than one replacement property as backup in the event problems arise with the first target acquisition property.  By identifying a second or third replacement property, you significantly increase your ability to successfully 1031 exchange.

A Delaware Statutory Trust (DST) can be one of the most powerful tools used today to successfully complete an exchange.  A DST can offer the flexibility of closing quickly and alleviate the burden of securing financing from lenders.

Since most DSTs are fully stabilized, investors can rely on best-in-class property management to handle all leasing efforts for simple, turnkey ownership.  By identifying a DST property as a backup, an investor can gain the confidence to successfully close his exchange by eliminating most issues associated with a traditional exchange.

Get the backup you need with Exchange-X, the leading DST investment platform that provides investors access to dozens of institutional grade replacement properties to choose from.

For more information, schedule a consultation with one of our experts or call 888-495-7355 today.

Exchange-X
Join Exchange-X by Marzo Capital Group.  Click the link above to create an account now and be the first to know about upcoming opportunities.

To request a list of current offerings, please email our support team at info@marzocapitalgroup.com or call us at (888) 495-7355.


Click the link above to Download your free copy of “The Power of 1031 Exchanges and Delaware Statutory Trusts (DSTs)” to learn more about how real estate can complement your portfolio.


Full Disclaimer Copyright 2007-2020 Marzo Capital Group. All rights reserved. 

The contents of this communication: (i) do not constitute an offer of securities or a solicitation of an offer to buy securities, (ii) offers can be made only by the confidential Private Placement Memorandum (the “PPM”) which is available upon request, (iii) do not and cannot replace the PPM and is qualified in its entirety by the PPM, and (iv) may not be relied upon in making an investment decision related to any investment offering by the respective issuer, or any affiliate, or partner thereof ("Issuer"). All potential investors must read the PPM and no person may invest without acknowledging receipt and complete review of the PPM. With respect to the “targeted” goals and performance levels outlined herein, these do not constitute a promise of performance, nor is there any assurance that the investment objectives of any program will be attained. These “targeted” factors are based upon reasonable assumptions more fully outlined in the Offering Documents/ PPM. Consult the PPM for investment conditions, risk factors, minimum requirements, fees and expenses and other pertinent information with respect to any investment. These investment opportunities have not been registered under the Securities Act of 1933 and are being offered pursuant to an exemption therefrom and from applicable state securities laws. Past performance are no guarantee of future results.  All information is subject to change. You should always consult a tax professional prior to investing. Investment offerings and investment decisions may only be made on the basis of a confidential private placement memorandum issued by Issuer, or one of its partner/issuers. Issuer does not warrant the accuracy or completeness of the information contained herein. Thank you for your cooperation. 

Securities offered through Emerson Equity, LLC Member: FINRA, SIPC (CRD#: 130032/SEC#: 801-71293,8-66296). Only available in states where Emerson Equity, LLC is registered. Emerson Equity, LLC is not affiliated with any other entities identified in this communication. 

For more information, read our Disclosures & Disclaimers.

The Highest Quality Alternative Investments Period.

888-495-7355
400 N Ashley Drive, Suite 1900, Tampa, FL 33602