Comprehensive Guide to 1031 Exchanges: Part 2 – Exchange Options and Working with a Qualified Intermediary

Under the Internal Revenue Code, taxpayers have three primary options for conducting a 1031 exchange. Delayed exchanges, reverse exchanges, and improvement exchanges all offer different benefits in different circumstances. But all three options necessarily involve working with a 1031 qualified intermediary, and taxpayers must meet all other pertinent requirements to establish their eligibility for indefinite tax deferral.

This is Part 2 of our Comprehensive Guide to 1031 Exchanges. In Part 1, we covered the basic eligibility and timing requirements for securing indefinite tax deferral under Section 1031 of the Internal Revenue Code. Here, we’re covering the different types of 1031 exchanges and the importance of working with a 1031 qualified intermediary throughout the process.

The Three Primary Options for Conducting a 1031 Exchange

In a “true” exchange, a taxpayer directly exchanges one property for another. However, in practice, this rarely happens. The vast majority of 1031 exchanges involve a series of transactions—with the taxpayer selling their relinquished property before buying their replacement property, or vice versa.

1. Delayed Exchanges

Delayed exchanges are the most common by far. In a delayed exchange, the taxpayer sells their relinquished property before buying their replacement property using the sale proceeds. This is allowed as long as the taxpayer meets the timing requirements we covered in Part 1 of this Comprehensive Guide, and as long as the taxpayer does not come into possession of the sale proceeds directly.

2. Reverse Exchanges

A reverse exchange follows the opposite sequence of events—the taxpayer begins by acquiring their replacement property, and then they sell their relinquished property after the fact. However, the taxpayer cannot take ownership of the replacement property until the exchange is complete, so the taxpayer must “park” the replacement property with an Exchange Accommodation Titleholder (EAT) formed with the help of their 1031 qualified intermediary.

3. Improvement Exchanges (“Build to Suit” Exchanges)

An improvement exchange (also referred to as a “build to suit” exchange) involves making desired improvements to a replacement property without triggering tax liability due to the receipt of “boot.” As a general rule, any sale proceeds not used for the purchase of a replacement property are classified as “boot” and subject to immediate federal taxation. However, this can be avoided by properly structuring an improvement exchange—which can be combined with a delayed or reverse exchange as desired.

Working with a 1031 Qualified Intermediary

Delayed, reverse, and improvement exchanges all require taxpayers to work with a 1031 qualified intermediary. Depending on the type of exchange a taxpayer chooses to pursue, the qualified intermediary’s role may involve:

• Holding the proceeds from the sale of the taxpayer’s relinquished property until they can be used for the acquisition of the taxpayer’s replacement property;
• Assisting with the establishment of an Exchange Accommodation Titleholder (EAT) to hold the taxpayer’s replacement property;
• Holding and disbursing the funds to be used for improving the taxpayer’s replacement property;
• Assisting with documenting the taxpayer’s compliance with the requirements for indefinite tax deferral under Section 1031 (including properly “identifying” a replacement property); and/or,
• Preparing all of the other documentation required to conduct a compliant 1031 exchange and ensure that the taxpayer will be prepared to withstand scrutiny from the IRS if necessary.

An experienced qualified intermediary will be able to provide advice throughout the process as well. When conducting a 1031 exchange, maintaining strict compliance with the Internal Revenue Code is essential, and an experienced qualified intermediary’s insights can prove invaluable.

FAQs: Choosing the Best Option for Your 1031 Exchange

What happens if I attempt to conduct a delayed exchange but I don’t acquire a replacement property in time?

If you attempt to conduct a delayed exchange but you don’t acquire a replacement property in time, you will lose your eligibility for indefinite tax deferral under Section 1031. As a result, meeting the deadline is essential. An experienced 1031 qualified intermediary can help.

When does it make sense to pursue a reverse 1031 exchange?

A reverse 1031 exchange can make sense in various scenarios. One of the most common scenarios is when a taxpayer identifies a desirable replacement property before they have listed their relinquished property for sale.

How do I choose a 1031 qualified intermediary?

When choosing a 1031 qualified intermediary, experience is one of the most important factors to consider. Your qualified intermediary will play a central role in your 1031 exchange, so you need to feel confident in his or her capabilities.

Schedule a Call with a 1031 Qualified Intermediary at 1031 National Services

At 1031 National Services, we have extensive experience guiding taxpayers through the 1031 exchange process. To speak with one of our experienced qualified intermediaries in confidence, call us at 888-872-1031 or request a free initial consultation online today.