A delayed exchange is the most common type of exchange. Certain IRS requirements must be met to structure a delayed exchange. Under this arrangement an investor may take advantage of the full exchange period to acquire a replacement property.
1. Open an Exchange – An investor must open an exchange with ERI prior to the close of escrow on the relinquished property.
2. Close Sale of Relinquished Property – Via an executed assignment, ERI assumes the purchase contract and instructs the closing agent to deed the relinquished property directly from the investor to the buyer. The proceeds from the sale are sent directly to ERI, thereby protecting the investor from the prohibited actual or constructive receipt of funds. The availability of these funds is restricted by the IRS.
3. Identification of Replacement Property – 45-Day Deadline – The investor must identify the replacement property before midnight of the 45th day of the exchange. The trigger date for the exchange deadlines, i.e. 45-day identification period and exchange period, is the day after the close of escrow for the relinquished property. A valid identification must be in writing, signed by the investor and sent to a qualified party within the 45 days. The property identified must be unambiguously described. ERI recommends the investor confirm receipt of the identification prior to the 45th day. An investor must follow one of the following two rules when identifying replacement property:
- The Three-Property Rule – An investor may identify a maximum of three (3) replacement properties without regard to their fair market value (“FMV”).
- The 200% Rule – An investor may choose to identify more than three (3) replacement properties. If so, the aggregate FMV of all the replacement properties identified cannot exceed 200% of the relinquished property value. If the 200% rule is exceeded, the investor must purchase no less than 95% of the aggregate FMV of the identified replacement properties or a failed exchange will result.
4. Acquire Identified Replacement Property – Exchange Period – Within the 180-day period, or before the investor’s tax filing date, the investor must close escrow on an identified replacement property. As with the relinquished property, the investor again assigns the purchase contract to ERI. The exchange funds are then transferred from ERI directly to the closing agent.
ERI cannot and does not provide advice regarding specific tax consequences. Investors considering a §1031 tax-deferred exchange should seek the counsel of their tax professionals to obtain tax advice.