Planning Your 1031 Exchange

The process may seem overwhelming, but we are here to help.

Step 1: Pre-planning and Structuring

The first step in any 1031 exchange is to plan. Planning should be done before you list a property for sale, and always should be done by a licensed attorney. For example:

Is the Relinquished Property being sold held by a partnership, LLC, or trust?
Do all of the owners want to exchange together or separately? If co-owners want to exchange separately, then you need a lawyer to structure a drop and swap, partnership division, or other transaction to allow co-owners to separate.
What will you exchange into? Think ahead, timing is tough in a 1031. We can help!

Pre-planning is critical because planning often can’t be done once a purchase and sale agreement is signed. For example, if you want to structure a “drop and swap” transaction whereby your LLC, parnership, or trust is dissolved and each co-owner can exchange separately, the structuring must be done before you sign a purchase and sale agreemeing. In states like California, the Franchise Tax Board (FTB) will challenge your 1031 exchange if you attempt to restructure your property after you contract to sell.

Step 2: List Your Property for Sale

Only AFTER all your pre-planning for your exchange is complete shoudl you consider listing your property for sale. You should only solicit advice from an attorney, CPA, or licensed tax professional. Never take 1031 advice from an unlicesed salesperson.

Upon completion of your pre-plannign with an attorney, you can list your property for sale and start soliciting offers. We are available to help you at each step of the process, and you should consult us prior to entering into a real estate purchase and sale agreement. We can advise you on the best legal language to include in your contracts to ensure that your 1031 exchange is completed successfully.

Step 3: Contract to Sell

The time has come and you have received a Letter of Intent or a Purchase and Sale Agreement. You should send us a copy of the contract to review before you sign it to make sure there are no issues. One of the most common issues we see relates to “1031 Exchange Cooperation Clauses.” This clause requires the Buyer to cooperate to allow you to complete your 1031 exchange. In any contract, you must have the right to assign the contract to a qualified intermediary. If you do not include this language, the Buyer of your Relinquiahed Propety may object and cause either the sale or your 1031 exchange to fail. Call us, as we are experts at drafting real estate purchase agreements as part of 1031 exchanges.

Step 4: Complete 1031 Exchange Documents

Once you are in contract to sell, you need to start the process of engaging a 1031 exchange qualified intermediary. We can arrange or provide the qualified intermediary services for you and handle all the paperwork. The steps you must take include:

Sign an Exchange Agreement, which is a document with us, as qualified intermediary, which states that we are acting as your qualified intermeidary, explains how we will hold your funds, and sets forth our obligations to use your funds to purchase and deliver your desired replacement property to you.
Assign your Real Estate Purchase and Sale Agreement to Us as Qualified Intermediary: You contracted to sell your relinquished propety as part of a 1031 exchnage, but now you need to assign that contract to us as we will facilitate your 1031 exchange. We will prepare an assignment agreemnet for you to sign.
Sign a Notice and Acknowledgement of Assignment of Real Estate Purchase and Sale Agreement: The law requires that you notify the buyer of your property that you have assigned the purchase and sale agreement to us. We will provide a form for you and the buyer to sign notifying the buyer of the assignment of contract.

Step 5: Close the Sale of Your Relinquished Property

Once all the exchange documents are signed and the buyer has removed their contingencies, you are ready to close. At this point, we will coordinate with your Escrow Agent or Title Company and do the following:

Closing Instructions: We will provide escrow with a Closing Instruction Letter explaining how they must close the trasaction to allow you to cmoplete a successful 1031 exchange.
Review Closing Statement: We will obtain and reivew the closing statement and advise you if there are any issues that may affect your 1031 exchange. For example, if you pay mortgage prepayment penalities or other loan charges with sale proceeds, the amount used to pay those charges is taxable to you as capital gain! We will help you structure your closing to minimize these potential taxes.
At Closing: At closing, your sale proceeds will be wired to us and held in a secure “Qualified Escrow Account” at a major national bank. You must approve disbursement of funds from this account, so we cannot move the funds without your signature.

Step 6: Contract to Purchase Replacement Property

Immediately upon sale of your Relinquished Property, or even before, you should be attempting to enter into contracts to purchase one or more Replacement Properties to complete your 1031 exchange. We will review any Letters of Intent or Purchase and Real Estate Purchase and Sale Agreements that you wish to sign to ensure there are no issues that might negatively impact your 1031 exchange.

Remember you only have 45 days to make a written identification of potential replacement properties to us, and we strongly advice you to have properties in contract prior to identifying them.

Step 7: Execute 1031 Exchange Documents for Replacement Property

Just like you did at the time of sale of your relinquisehd property, you will need to execute 1031 exchange documents for your replacement property. These docuemnts are very simlar to what you signed before:

Assign your Real Estate Purchase and Sale Agreement to Us as Qualified Intermediary: You contracted to purchase replacement proeprty as part of your 1031 exchnage, but now you need to assign that contract to us as we wll purchase the replacement property for you using your funds from the sale of your relinqished property. We will prepare an assignment agreemnet for you to sign.
Sign a Notice and Acknowledgement of Assignment of Real Estate Purchase and Sale Agreement: The law requires that you notify the seller of the relinquished property that you have assigned the purchase and sale agreement to us. We will provide a form for you and the seller to sign notifying the seller of the assignment of contract.

Step 8: Complete Your 45 Day Identification Form

The law requires that you make a written identification to us within 45 days of the sale of your relinquished property listing the properties that you intend to purchase. Failure to complete this 45 day identification form is fatal to your exchange. You must identify properties using one of several methods:

Three Property Rule: You can identify any three (3) properties and acquire one, two, or all three of them to complete your 1031 exchange.
200% Rule: You can identify any number of properties with a fair market value purchase price of up to 200% of the GROSS sales price of your relinquished property, and you can then acqurie any number or combination of the identified properties to complete your exchange.
95% Rule: You can identify any number of properties of any value, but you must acquire 95% of what you identified in order to successfully complete a 1031 exchage.

NOTE: Identifying DST properties (Delaware Statutory Trusts) on a 45-Day Identification form can be tricky and we have had to defend multiple 1031 exchange audits relating to ID forms that are not correctly filled out. If you are considering identifying DST properties, make sure you talk to us before you fill out your ID form. Often times, errors are made at the advice of brokers or other qualified intermediaries which are NOT lawyers or CPAs.

Step 9: Close the Purchase of Your Selected Replacement Properties

You have copleted your due diligence, any financing is approved, you have removed contingencies, and you are ready to close the purchase of your replacement property or properties. At this point, we will coordinate with your Escrow Agent or Title Company and do the following:

Closing Instructions: We will provide escrow with a Closing Instruction Letter explaining how they must close the trasaction to allow you to complete a successful 1031 exchange.
Review Closing Statement: We will obtain and reivew the closing statement and advise you if there are any issues that may affect your 1031 exchange. Similar to the sale of your relinquished property, we will reivew the closing statement to make sure that you are not making an error that will result in your owing taxes.
At Closing: At closing, we will use your proceeds from the sale of your relinquished property to acquire replacmeent properties and deliver the replacement property to you. Title will pass directly from the seller to you, and we will never hold legal title.