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IRC 1031 Defered Exchange - What happens? |
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The
following outline is based on the Final Regulations
that were issued by the IRS on April 26, 1991.
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Two Types of Deferred Exchanges |
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Delayed Exchanges - the most popular method of completing a Deferred Exchange and the method discussed in this outline.
Concurrent Exchanges - not as popular method of completing a Deferred Exchange |
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1. Concurrent Exchanges : |
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Not
as popular a method of completing a Deferred Exchange.
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- Requires same title and escrow holder (due
to collected funds regulations)
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Seller of Replacement Property acts as Intermediary
and is substituted into the sale transaction
as the Seller for the Relinquished Property
- Professional Intermediary can be used to
limit the drawbacks of having individual act
as the intermediary.
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2. Delayed Exchange : |
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PARCEL
I - "RELINQUISHED PROPERTY" (can include
multiple relinquished properties)
A. Taxpayer's intent to exchange - declare as
often as possible. |
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- The listing agreement
- The purchase agreement
- The escrow instruction
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B.
Taxpayer decides on his "Qualified Intermediary"
- as soon as possible |
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What
can be a qualified Intermediary? |
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What
is a Qualified Intermediary? |
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Facilitates completion of IRC 1031 Exchange
- Has
an Exchange Agreement setting forth all the
terms, conditions and duties of the intermediary
while holding taxpayer's funds
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Charges a fee for services rendered
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Who can be a Qualified Intermediary? |
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A
qualified intermediary is a person who is not
the Taxpayer or a related party and who acts to
facilitate a deferred exchange by entering into
an exchange agreement with the taxpayer for the
exchange of properties. Corporation versus Individual
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A Corporation acting
as an intermediary is an on-going entity
that will not be affected by the change
or death of the person that conducts
the business of the corporation
- An individual acting as an intermediary
can become subject to estate laws if death
should occur during the exchange period.
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Choose Intermediary Carefully |
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- No controls in California - some states have
started regulating
- No guarantees; Only real assurances are intermediary's
reputation and the Exchange Agreement.
- Escrow Holder will need to provide Intermediary
with escrow instructions and a preliminary title
report covering the relinquished property.
- Purchase money notes generated in the Parcel
I escrow - it is important to have the Taxpayer
advise as soon as possible what to do with purchase
money paper, if it is part of the Relinquished
Property transaction. This is where it is very
important to have tax accountant/attorney opinions.
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A |
Installment sale treatment of new purchase money |
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B |
Now
the note can be assumed by the Buyer of
the replacement property and executes an
Assumption and Release of Liability that
releases the Intermediary of the obligation
to pay the note. |
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C |
Can
be held by Intermediary during the exchange
period and then assigned to Seller/Taxpayer
during the exchange period - may then be taxable
as boot. |
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D |
Sold
during the exchange period and the funds received
by the Intermediary become part of the taxpayer's
account. |
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6. Intermediary will be asked to provide the
following to the Escrow Holder: |
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A |
"Substitution
of Seller Amendment" - this amendment
to the relinquished property takes out the
Seller/Taxpayer and substitutes in the Intermediary
as the seller. This amendment provides for
the payment of the fee and also for the delivery
of the net proceeds to the Intermediary at
the close of escrow. |
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B |
Articles
of Incorporation and a copy of the Corporate
Resolution that allows the Intermediary to
acquire and transfer properties and who can
sign to conduct business for the corporation
(only required when the Intermediary is a
corporation). |
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C |
A
signed and notarized grant deed from the
Intermediary to the Buyer of the Taxpayer's
property if a purchase money note and trust
deed are being created for an installment
sale. This process is called "sequential
deeding" because the deeds follow a
sequence from the seller/taxpayer to the
intermediary and then to the buyer of the
relinquished property. |
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D |
The
IRS has stipulated that deferred exchanges
can be closed by a process call "direct
deeding". This is the most common practice
used by all intermediaries because it allows
the intermediary to handle the deferred
exchange without actually taking title to
the property, which further eliminates liability
on the part of the intermediary for the
any possible high risk conditions of the
relinquished property |
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7. Intermediary will be asked to provide the following
to the Escrow Holder: |
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A |
Closing
statement must reflect the Intermediary
as the Seller. The HUD-1 can show the Taxpayer/Seller
for the purposes of furnishing less confusing
documentation to the Buyer's lender. |
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B |
The
net proceeds check is payable to the Intermediary
(the check is either written directly to
the intermediary or to an escrow for the
credit of the Intermediary depending on
the instructions given by the Intermediary)
and delivered to the Intermediary along
with a copy of the closing statement. |
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C |
After
the close of escrow any check holds or refunds
due from payoffs or overpayments are forwarded
to the Intermediary when received by Escrow
Holder. |
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D |
Funds
are held by Intermediary and invested according
to the Exchange Agreement or other agreements
made between the Taxpayer and the Intermediary
until such time as the Taxpayer directs
the Intermediary to proceed with the close
of the Taxpayer's Replacement Property.
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The
Exchange Period |
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Count
exact days on the calendar, the IRS does not provide
any grace periods. |
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Identification Period |
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Beginning
on the day as day 1after the date of the close
of escrow of the Taxpayer's Relinquished Property
(Parcel I) and counting that day as day 1.
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Taxpayer has 45 calendar days in which to identify
the Replacement Property(ies) (Parcel II). |
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How To Identify |
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Exchange Period |
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Beginning on the day after the date of the close
of escrow of Taxpayers Relinquished Property
(Parcel I) |
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180
- calendar days from close of Relinquished
Property (Parcel I) to close escrow
on Replacement Property (Parcel II),
or
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The
due date (including extensions) for the
Taxpayer's tax return for the taxable
year in which the transfer of the Relinquished
Property occurs.
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Multiple
Parcels in the same delayed exchange
will require extra attention to these
deadlines. The 45 days start with the
close of the first Relinquished Property
and the last Replacement Property must
close within the 180 days.
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There
is, also, the option of entering multiple
Relinquished properties into separate
deferred exchanges if the time limits
are causing a problem or may not be met.
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Identiciation of The "include multiple Replacement
Properties" |
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The"include
Replacement properties" is treated as identified
for purposes of Section 1031 only if it is designated
as replacement property in a written document
signed by the taxpayer and hand delivered, mailed,
telecopied, fax'd, or otherwise sent before the
end of the identification period to a person involved
in the exchange other then the taxpayer or a related
party. |
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Taxpayer may identify more than one property
as the Replacement Property. However, regardless
of the number of Relinquished Properties
transferred by Taxpayer as part of the same
deferred exchange, the maximum number of
Replacement Properties that the Taxpayer
may identify is. |
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Parcel
II - Replacement Property |
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can Include Multiple Replacement Properties |
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1.
Taxpayer finds property and opens escrow. Escrow
instructions should include a clause that this
escrow is the consummation of the Taxpayer's delayed/deferred
exchange. |
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The
initial deposit into the Taxpayer's Replacement
Property escrow can be made by Taxpayer or
Intermediary at Taxpayer's option.
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Taxpayer
signs escrow instructions and tells Escrow Holder
the name of the Intermediary.
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Escrow
Holder sends Intermediary escrow instructions
and preliminary title report covering the
Replacement Property.
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2.
Taxpayer finds property and opens escrow. Escrow
instructions should include a clause that this escrow
is the consummation of the Taxpayer's delayed/deferred
exchange. |
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Substitution of Buyer amendment to escrow instructions,
substituting the Intermediary into the escrow
as the Buyer.
- A
signed and notarized grant deed with a completed
and signed PCOR from the Intermediary to the
Taxpayer if sequential deeding is being done.
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Articles
of Incorporation and a copy of the Corporate
Resolution setting forth who can sign for
the corporation and stating that the Intermediary
can acquire and sell properties. (Only required
when the Intermediary is a corporation.)
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3.
At the close of escrow the Buyer of the Taxpayer's
property is the Intermediary and the proceeds and
statements are handled as follows: |
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Closing
statement must reflect the Intermediary as
the Buyer. .
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RESPA HUD-1 can reflect the Taxpayer as the
Buyer in order to furnish the lender with a
HUD-1 that matches the new loan.
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The
refund/over deposit check is written to the
Intermediary (the check is either written
directly to the Intermediary or to an escrow
for the credit of the Intermediary depending
on the instruction OF the Intermediary) and
delivered to the Intermediary along with a
copy of
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Completion of The Delayed Exhange
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1.
Intermediary should provide the Taxpayer with
the following at the completion of the exchange:.
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A |
Exchange
Statement (combining into one statement all
Relinquished Property(ies) and all Replacement
Property(ies). |
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Refund
of any money left in delayed exchange: |
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Refund
of Taxpayer's deposit in Replacement Property
escrow(s) .
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Rents
or deposits (security, cleaning, key) can be
paid separately .
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Reflect
any growth factor (interest) credit
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Balance
of Taxpayer's funds (including any boot)
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2
For reporting purposes the Deferred Exchange is
considered opened o the date of the close of the
Relinquished Property (Parcel I - or the close
of the first Parcel I) and closed on the day of
the close of the Replacement Property (Parcel
II - or the close of the last Parcel II). |
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Safe Harbors |
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There
are four (4 ) safe harbors in the regulations.
Safe Harbors may attempt to provide the Taxpayer
with a certain amount of "security"
concerning the funds being held by the Intermediary,
without creating a circumstance that would expose
the taxpayer adversely to" constructive receipt"
rules. Each of these safe harbors provides that
the Taxpayer's "rights must be limited to
certain specified circumstances". |
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1.
Obligation of taxpayer's transferee is permitted
to be secured or guaranteed by: |
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2.
Qualified "escrow" account (not clearly
defined) |
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3.
Facilitation of deferred exchange by Intermediary.
Property can be transferred by a direct deed. |
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4.
Taxpayer is permitted to receive interest or a growth
factor. |
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Must
be treated as interest whether it is cash
or property .
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Not
available to Taxpayer until the Deferred Exchange
is closed.
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Will
be reported on a 1099 as interest income.
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Balance
of Taxpayer's funds (including any boot)
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Seek
Advice : |
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- A Corporation acting as an intermediary
is an on-going entity that will not be
affected by the change or death of the
person that conducts the business of the
corporation
- An individual acting as an intermediary
can become subject to estate laws if death
should occur during the exchange period.
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