1031 Exchange-what are the benefits and pitfalls?

A sale of property followed by a purchase of property of "Like-Kind" without an Intermediary does not qualify as a "Like-Kind" exchange. There must be a true exchange, instead of a transfer of property for money. The Regulations define a deferred exchange as "an exchange in which, pursuant to an agreement, the taxpayer transfers property held for productive use in a trade or business or for investment (the 'relinquished property') and subsequently receives property to be held either for productive use in a trade or business or for investment (the 'replacement property')." Both relinquished property and replacement property must be held for a qualifying use by the taxpayer as the terms "relinquished property" and "replacement property" are used in the Regulations.

There are many benefits for sellers under Section 1031:

·  Risks from one, high-valued property can be shifted into several lesser-valued replacement properties to diversify the investment;

·  Management-intense properties can be sold and replaced with more manageable properties;

·  Property owners who move to a new geographic location can relocate their equities;

·  Combining a Section 1031 transaction for the down payment on the property sold with the deferred profit reporting of a Section 453 installment sale on a carry back note for the balance of the equity on the property sold;

·  Exemption from reporting all or a portion of the profit on the sale;

·  No recapture of any excess acceleration depreciation;

·  Debt leverage and income yield can be increased by replacing property currently owned with higher-priced and more productive property;

·  A fresh start allocation of basis between buildings and land, establishing new depreciation deductions which can be increased by assuming greater debt on higher priced replacement property;

·  The equities from several properties can be consolidated (by one owner or more) into a single more efficient property;

·  Can be utilized as a mechanism for estate liquidation.

Find an experienced professional Qualified Intermediary, such as NCS Exchange Professionals, to assist you with the exchange as early in the sale process as possible. At a minimum, you should require the Qualified Intermediary to provide fidelity bond insurance coverage. Then instruct your real estate agent to include an "Exchange Cooperation Clause" as an addendum to the purchase and sale agreement on the relinquished property (the property the Exchanger is selling to the buyer). Contact your Qualified Intermediary as soon as possible after the escrow is opened or after entering into the purchase and sale agreement and advise them of your intent to do an exchange well in advance of the closing date. The Qualified Intermediary will draft the appropriate Exchange Agreement, Assignments and Exchange Closing Instructions that must be executed prior to closing on the property being sold. Then, begin searching for acceptable replacement property immediately to ensure that you can meet the strict time frame for the 45-day Identification Period.