The forward 1031 exchange is one of many types of 1031 tax deferred exchanges. Also known as a delayed exchange, in a forward 1031 exchange, the relinquished or old property is sold by assigning the rights of the Purchase and Sale Agreement (PSA) to the qualified intermediary who instructs the title company to direct deed the property to the buyer. A Notice of Assignment is signed by the buyer. An Exchange Agreement is then signed by the Exchangor. The net equity is then wired to either the replacement property closing, if scheduled to closed within a couple of days, or to an escrow account established under the Exchangor’s tax identification number. The funds are held in the escrow account until needed for the replacement property closing to occur within 180 calendar days of the relinquished property closing.
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 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 PSA, 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 PSA effectively enables the qualified intermediary to become the seller of the relinquished property and to receive the exchange funds from the sale for use 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.
Deferred Improvement Exchange
Another form of the forward 1031 exchange is when a Deferred Improvement Exchange, improvements are to be made on the replacement property using the exchange proceeds. The steps are similar to a forward 1031 exchange, except an Exchange Accommodator Titleholder, (EAT) acquires the replacement property on behalf of the Exchangor and holds title. The Exchangor oversees the construction, approving vendor invoices that are paid by the qualified intermediary. It is critical to include a description of the improvements on the identification letter. The 45th and 180th calendar day timeframe requirements still apply. No later than the 185th calendar day post relinquished property closing, the EAT conveys title to the Exchangor. For states that impose transfer taxes, attention should be given towards understanding whether a transfer tax is due at time of recording.
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