Comprehensive Guide to 1031 Exchanges: Part 3 – Conducting, Closing, and Reporting the Exchange

Conducting a 1031 exchange provides the opportunity to indefinitely defer federal tax liability on gain realized from the sale of appreciated real estate. But strict requirements apply, and failure to comply with any of them can result in the loss of tax deferral eligibility. This makes it critical to work closely with a 1031 exchange expert throughout the process.

This is Part 3 of our Comprehensive Guide to 1031 Exchanges. In Part 1, we covered the basic eligibility and timing requirements for securing indefinite tax deferral. In Part 2, we discussed the differences between the three main types of 1031 exchanges. Here, we’re covering the procedural requirements for establishing compliance with Section 1031 of the Internal Revenue Code and reporting an exchange to the IRS.

Conducting and Closing a 1031 Exchange

Since the vast majority of 1031 exchanges involve selling one property and then buying another (or, in the case of a reverse exchange, proceeding in the opposite order), conducting a 1031 exchange is necessarily a multi-step process. With a typical delayed exchange, the key steps in the process are as follows:

• Engaging a qualified intermediary (QI) to manage and facilitate the like-kind exchange
• Securing a purchaser for the property to be sold (the “relinquished” property)
• Selecting and formally identifying the property to be purchased (the “replacement” property)
• Closing on the sale of the relinquished property with an acknowledgment that the sale is part of a 1031 exchange
• Placing the proceeds from the sale of the relinquished property directly into trust with your QI
• Conducting due diligence on the replacement property
• Structuring and documenting the acquisition of the replacement property as a like-kind exchange under Section 1031
• Using the proceeds held in trust to acquire the replacement property

As we discussed in Part 1, there are two critical deadlines during this process—taxpayers have 45 days to formally “identify” a replacement property after selling their relinquished property, and they have 180 days to close on the acquisition of their replacement property after selling their relinquished property. Taxpayers should work with their QI to ensure they clearly document their satisfaction of both deadlines so they can demonstrate compliance with the IRS if necessary.

Reporting a 1031 Exchange to the IRS

Taxpayers must report all 1031 exchanges to the IRS. This is done using IRS Form 8824 (Like-Kind Exchanges). If a taxpayer completes their entire 1031 exchange in a single tax year, IRS Form 8824 is due with the taxpayer’s annual return for the tax year in which the exchange was conducted.

If a 1031 exchange straddles two tax years, IRS Form 8824 is due with the taxpayer’s annual return for the tax year in which the relinquished property was sold—not the year in which the replacement property is acquired. Like other IRS forms, filing IRS Form 8824 late can lead to penalties and other adverse consequences.

FAQs: Conducting a 1031 Exchange and Securing Indefinite Federal Tax Deferral

Do I need a qualified intermediary (QI) to conduct a 1031 exchange?

Yes, conducting a 1031 exchange generally requires the involvement of a qualified intermediary (QI). Working with a QI is necessary to meet the statutory requirements for conducting delayed, reverse, and improvement exchanges—including the requirement that taxpayers not take direct possession of the sale proceeds from their relinquished properties.

What documentation do I need when conducting a 1031 exchange?

Conducting a 1031 exchange requires several forms of documentation. These include an exchange agreement with a QI, purchase and sale agreements that include the requisite language for 1031 exchanges, formal “identification” of the replacement property, and IRS Form 8824, among others. Once you engage a QI to assist you, your QI will be able to help ensure that you have all of the documentation you need to substantiate compliance with Section 1031 of the Internal Revenue Code.

How do I start a 1031 exchange?

Starting a 1031 exchange involves engaging an experienced QI who can guide you through the process. Not only is engaging a QI beneficial for several reasons, but it is also necessary to meet the requirements under Section 1031.

Schedule a Free Consultation with a 1031 Exchange Expert Today

If you would like more information about the steps involved in conducting a 1031 exchange, we invite you to get in touch. To schedule a free consultation with a 1031 exchange expert at 1031 National Services, please call 888-872-1031 or contact us online today.