Rules for Every Tax-Deferred Exchange:

1. Exchange Like for Like: Remember that property sold and purchased must be investment property, used for trade or business purposes, or used for the generation of income. Like-kind property refers to the intended use of the real property, not the type of real property, as investors often believe. Like-kind property exchanges may for example include any of the following: bare land for a rental house, duplex for a fourplex, retail center for an apartment complex or an office building.
2. Exchange Even or Up in both Net Equity and Net Value: If not, a recognized (taxable) gain will occur.
3. Identify acceptable property or properties within 45 days of sale date: All replacement property must be identified in writing! There are three rules that limit the number of properties that can be identified, and the taxpayer must meet the requirements of one of these rules. There is no extension to the identification period!
   • Three Property Rule – you may select no more than three properties; there is no price limit. You may substitute one selection for another during the 45 day period.
   • 200 Percent Rule – you may select any number of properties; however, the total price of the properties must not exceed twice the price for which you sold the relinquished property.
   • 95 Percent Rule – any replacement property identified before the end of the 45-day identification period and received before the end of the exchange period qualifies, but only if the exchanger receives identified replacement property constituting at least 95 percent of the aggregate fair market value of all identified replacement properties.
4. Acquire replacement property within 180 days of sale date or before filing your tax return for the year of the sale .
5. Use a qualified intermediary (QI): This intermediary is employed by an exchange agreement to hold and disburse funds for the benefit of the exchangor.
   • The exchangor cannot have actual or constructive receipt of exchange funds. Exchangor cannot receive funds, borrow against funds, or direct their use. Sale proceeds will remain in an Exchange Value Account (EVA) during the exchange, where they are outside of the exchangor's control.
   • The “QI” cannot be an agent or nominee of the exchangor.
   • Funds are used to acquire replacement property and pay for closing costs associated with the purchase.

Role of the QI:

• Exchangor signs Exchange Agreement
• Exchangor assigns relinquished property to the QI
• QI transfers property to buyer
• QI holds sale proceeds in EVA
• QI acquires replacement property for exchangor, but does not findproperty, negotiate contract…

Exchange Cooperation Clause:
The Purchase and Sale Agreement should contain language that establishes the Exchangor's intention to exchange and gains the other party's agreement to cooperate. The ‘Cooperation Clause' serves the purpose of disclosing the exchange, which is required by IRS regulation. Some suggested language is:

Relinquished property:
“Buyer hereby acknowledges that it is the intention of the Seller to complete an IRC 1031 exchange which will not delay the close of escrow or cause additional expense to the Buyer. The Seller's rights and obligations under this agreement may be assigned to an Intermediary of the Seller's choice for the purpose of completing such an exchange. Buyer agrees to cooperate with the Seller and the Intermediary in a manner necessary to complete the exchange.”

Replacement property:
“Seller hereby acknowledges that it is the intention of the Buyer to complete an IRC 1031 exchange which will not delay the close of escrow or cause additional expense to the Seller. The Buyer's rights and obligations under this agreement may be assigned to an Intermediary of the Buyer's choice for the purpose of completing such an exchange. Seller agrees to cooperate with the Buyer and the Intermediary in a manner necessary to complete the exchange.”

Additional questions about escrow, title or 1031 exchange transactions? Please visit our frequently asked questions link.