The most common type of 1031 exchange is often called a Forward 1031 Exchange, but you may have also heard it called a “Starker Exchange”,“Delayed Exchange” or “Like-Kind Exchange.” All of these terms refer to the same type of 1031 exchange. A forward 1031 exchange is when the old or relinquished property is sold and closed before the replacement or new property is purchased and closed.
For example, a taxpayer enters into a contract or agreement to sell real property held for use in business or investment. The property closes, the associated debt is paid off and the remaining net proceeds are wired to escrow under your tax identification number. Once the replacement property is in contract for an equal or greater amount, a second closing is scheduled, net proceeds are wired and the forward 1031 exchange is completed.
A Forward 1031 Exchange defers the federal and state capital gain and recaptured depreciation tax triggered when the old property is sold and replaced with a property of equal or greater value. The indefinite, interest-free loan is used towards buying the new property. It is essential that a 1031 exchange is prepared prior to the closing of the relinquished property, you cannot set up a 1031 exchange after the relinquished property has closed.
Seven Steps to a Forward 1031 Exchange
The steps of a forward exchange include:
- The Exchangor engages Atlas 1031 Exchange to accommodate the 1031 exchange by signing an engagement letter and completing a W-9. The W-9 is required by the bank to open a qualified escrow account on behalf of the Exchangor.
- Sale of the old or relinquished property is negotiated and a Real Estate Sales contract is signed. Remember to include 1031 assignment language in the contract. This is not required, but it is suggested to alert all parties to the sale of the intent to initiate a 1031 exchange.
- At the first of two closings, the Exchangor signs the traditional closing documents and 1031 exchange documents. The Buyer will also sign a Notice of Assignment. The IRS requires that all parties to the exchange are notified in writing.
- Net 1031 exchange proceeds are wired to a custodial banking partner for deposit into a non-commingled, qualified escrow account under the individual’s social security number or company’s employer identification number. If the Exchangor is not a US citizen, then the funds are wired to an account under their international tax identification number, or employer identification number if relinquished property is titled to a foreign corporation.
- The identification and replacement period begins the day following the closing. The Exchangor must identify the potential replacement properties by the 45th calendar day or the 1031 exchange ends on the 46th calendar day and the 1031 exchange funds are returned to the Exchangor with interest earned. Replacement property must be purchased within 180 calendar days from closing.
- Real Estate Purchase Agreement is signed by the Exchangor for the replacement property. Remember to include the replacement 1031 assignment language in the contract. The replacement property must be identified on the 45 identification form to the qualified intermediary.
- Closing is scheduled where traditional closing documents are signed along with 1031 exchange documents. 1031 exchange proceeds are wired prior to closing.
The Two Phases of a Forward 1031 Exchange
Identification Phase
In a forward 1031 exchange, replacement property is to be formally identified to the qualified intermediary by the 45th calendar day post-closing, listing the addresses of up to three properties regardless of value, or four or more given the total value does not exceed two hundred percent of the relinquished property sales price. An identification form is provided by the Qualified Intermediary along with a letter identifying the 45th and 180th calendar day of the forward 1031 exchange.
Should no properties be identified, the forward 1031 exchange ends at 12:00 AM on the 45th calendar day post relinquished property closing. Exchange funds held in the Exchangor’s escrow account are wired the following business day, ending the exchange. If the net equity and debt retired at the relinquished property closing is not replaced with a replacement of equal or greater value, then federal and state capital gains and recaptured depreciation taxes are due when the Exchangor files their federal tax return.
Replacement Phase
The replacement property can be acquired at any time in the forward 1031 exchange. In a simultaneous 1031 exchange, the old and new property can be closed on in the same closing or same day. If the replacement property is to be acquired within days of the relinquished property closing, it is suggested to separate the closings by a couple of days to allow for the exchange fund wire to clear the banks. Otherwise, the closing staff is anxiously waiting for the exchange funds to be received.
The rights of the replacement property contract, but not the obligations, are assigned to the Qualified Intermediary who instructs the title company to direct deed the replacement property from the seller to the Exchangor. A Notice of Assignment is signed by the seller.
The Assignment of rights to the contract effectively enables the Qualified Intermediary to become the seller of the relinquished property and to receive the exchange funds from the sale to acquire the replacement property as the buyer. A 1031 exchange is a series of interdependent steps requiring strict adherence to the requirements set forth in Internal Revenue Code Section 1031.
Contact Atlas 1031 for your Forward 1031 Exchange
In addition to the tax deferral, the benefits to a 1031 exchange include replacing an asset that produces cash flow from one that does not, consolidating properties into one or diversifying into many. All 1031 exchanges are either forward, reverse (acquiring the replacement property prior to selling the old) or simultaneous (closing on the old and new property at the same time).
If you’re considering a Forward 1031 Exchange, reach out to us via the consultation form below or call us today at 800.227.1031.
