How to Properly Close Your 1031 Real Estate Exchange

1031 real estate exchanges allow you to sell your property without incurring capital gains taxes. This is done by exchanging one property for another. This is called a 1031 tax exchange. The properties that are exchanged should be held for productive use in a trade or business, or used for investment. Stocks, bonds, and other properties are expressly excluded. Securitized properties, however, are not excluded. The exchanged properties must be similar. There is sound reasoning behind the 1031 real estate exchange. When an investor exchanges one property for another, there is no real gain, so it is not fair to tax this “paper” gain. 1031 exchanges are tax-deferred, not tax free. Taxes still must be paid when the replacement property is sold. This is when the original deferred gain, plus any additional gain, is taxed.

The Qualified Intermediary

You must hire a qualified intermediary in order to do a 1031 real estate exchange. Qualified intermediaries have at least four responsibilities:

  • prepare the legal agreement and other related documents
  • hold and protect the funds while they are being exchanged
  • coordinate the entire transaction
  • keep the transaction in accordance with the income tax regulations.   

Documents Needed

You need to make sure to provide the necessary documents in order to close the transaction properly. You will need:

  • a copy of the purchase and sale contract
  • a copy of the Preliminary Title Insurance Report or the Title Insurance Commitment
  • a copy of any Escrow instructions surrounding the exchange.
  • the investors contact information
  • the closing or escrow agent’s file number
  • the escrow agent’s estimates closing statement (HUD-1)

Remember that you will already be engaging in the 1031 exchange before closing. You should have already hired a qualified intermediary. This intermediary receives the proceeds, and then holds the money until the close of the new property. If you close the property before doing these things, you will not be able to take advantage of the 1031 exchange.

After doing these things, you have to find the replacement property. You must find this new property within 45 days of the sale of your old property. This is an IRS law. You may identify one to three possible replacement properties. In some cases, it is possible to identify more. If your top choice does not close, you might consider tenant in common properties as a backup. Remember that the replacement property must be of equal or greater value to the relinquished property.

Buy the Replacement Property

After you sell your old property, you must obtain the replacement property within 180 days. The closing costs are paid by the qualified intermediary. After this, you will receive the deed to the replacement property. At this point, you have exchanged  properties, and not paid a cent of tax!

Hiring an Exchange Professional

It is easy to be confused by this entire process. If you want to hire a professional, be certain it is a 1031 exchange professional, to make sure you are compliant with the tax code.

blog comments powered by Disqus