1031 Exchanges of certain types of property may defer the recognition of capital gains or losses due upon sale, and hence defer any capital gains taxes otherwise due. Consulting with your financial advisor, tax attorney and/or your CPA is always recommended. The following is intended to be used as an introduction to exchanges:
Forward Delayed Exchanges
In the most commonly executed exchange transaction, a Forward Delayed Exchange, property is sold (Relinquished Property), and the proceeds are then used to purchase another “like-kind” property (Replacement Property) In order for the exchange to qualify for tax-deferral under the safe harbor regulations, the sale proceeds must be held on behalf of the Taxpayer by a Qualified Intermediary.
There are two versions of this exchange transaction. In the first version, two properties are “swapped” by two parties who want to simply trade properties. Taxpayer A gives his property to Taxpayer B, in return for Taxpayer B’s property. The other version of this exchange involves the sale of one property and the simultaneous acquisition of another. The Exchanger sells Relinquished Property to one party and then immediately acquires Replacement Property from a third-party. To ensure that this exchange qualifies for tax-deferral under the safe harbor regulations, the Taxpayer should engage the services of a Qualified Intermediary.
In a Reverse Exchange, the eventual Replacement Property is acquired before the sale of the Relinquished Property. Since the taxpayer has yet to sell Relinquished Property, the taxpayer may not hold the Replacement Property. Therefore, the eventual Replacement Property is “parked” by an unrelated third-party, referred to as an Accommodating Titleholder, until the Relinquished Property is sold. In order to qualify for tax-deferral under the safe-harbor regulations, the Parked Property must be acquired as Replacement Property within 180 days from the day the Accommodating Titleholder purchased it. The fees associated with these exchanges are higher due to the transactional complexity.
In a Construction Exchange (also known as a “Build-to-Suit” Exchange), the exchange proceeds from the Relinquished Property sale are used to acquire the Parked Property, and to construct improvements on the property. The property must be held by the Accommodating Titleholder until either the improvements are complete or the 180 day exchange deadline occurs. On or before the 180th day, the improved property must be transferred to the Exchanger as the Replacement Property, in completion of the exchange. These transactions may also be structured as Reverse Construction Exchanges. The fees associated with both of these exchanges are higher due to the transactional complexity.