Why Exchange?

• Avoid Taxes
• Leverage Assets
• Consolidate
• Diversify
• Relocate
• Change Passive Investment to Active
• Change Active Investment to Passive
• Remedy Poor Investment Choice
• Life Change
• Estate Planning

What is an IRC Section 1031 Exchange?

It is an exchange of property held for productive use in a trade or business or for investment for other "like kind" property held for productive use in a trade or business or for investment.

Any taxpayer benefits who has recognizable gain in qualifying property on which they will pay capital gains tax. It is strongly suggested that you consult with your tax advisor to determine the actual tax benefit to you.

To begin an exchange it is best to put a "cooperation clause" in the sales agreement. This puts the buyer and the escrow officer on notice that it is the seller's intent to complete an exchange. Ask the escrow officer to send a copy of the sale agreement and the preliminary title report to American Property Exchange, Inc. They will prepare exchange documents to be signed at closing. The exchange fee is usually paid from the proceeds.

The following properties are not eligible for a 1031 Exchange:

• Primary residences
• Second homes
• Personal Vacation Property
• Property held for resale
• Inventory
• Interests in Partnerships
• Shares in Corporations
• Collateral

In a 1031 exchange, "like kind" refers to the character of the property rather than its use. Most real property which is held for productive use in a trade or business or for investment will qualify. Real property must be exchanged for other real property.

A good "cooperation clause" will not only provide the required notice to all parties, it will indicate the Seller's/Buyer's rights may be assigned to an accommodator and will require the Buyer's/Seller's cooperation in the facilitation of the exchange.

Suggested Language

Buyer (Seller) hereby acknowledges that it is the intention of Seller (Buyer) to complete an IRC 1031 exchange which will not delay the close of escrow or causer additional expense to Buyer (Seller). Seller's (Buyer's) rights and obligations under this agreement may be assigned to American Property Exchange, Inc. for the purpose of completing such an exchange. Buyer (Seller) agrees to cooperate with Seller (Buyer) and American Property Exchange in a manner necessary to complete the exchange.

Any party not disqualified under the regulations may act as your accommodator Disqualified parties include relatives and controlled business entities, your realtor, CPA and attorney. You will want to choose a reputable accommodator with experience and financial security.

American Property Exchange, Inc., is backed by one of the nation's most financially secure multi-million dollar holding companies. The expertise of our staff developed through their 100 years of combined service in the real estate industry is your assurance of superior performance.

When the first property sells, American Property Exchange, Inc., is assigned in as seller. The closing documents are signed by the accommodator and approved by the taxpayer. To prevent constructive receipt, the proceeds are delivered to the accommodator and held for the purchase of replacement property.

All proceeds do not have to be reinvested. Escrow may be instructed to disburse a portion of the funds to the taxpayer an the balance to the accommodator. The exchange agreement needs to be amended to allow for this. Disbursement at the close of the sale or unused funds at the close of the exchange will not disqualify the exchange; however, such funds will be considered "boot."

The selling price can include a purchase money note and mortgage. However, it may complicate the exchange. If the note is to be used in the exchange, it must be put into the name of the accommodator. The note must then be assigned to the seller of the replacement property or converted to cash prior to closing on the replacement property. If neither is accomplished, the note will be assigned to the taxpayer who will pay taxes on any recognized gain.

The escrow company acts upon receipt of written instructions from the seller and buyer. To leave the money in escrow, it is necessary to give instructions. This is control of the proceeds and may invalidate the exchange.

After the property closes the exchange company will send you a form for the purpose of identifying your replacement property. This form needs to be returned within 45 days of the date the taxpayer transfers the relinquished property. There are rules which limit identification to three properties or 200% of the fair market value of the relinquished property.

You negotiate the terms of your purchase agreement which is then submitted to escrow. The exchange company is assigned in as buyer and provides the exchange funds to escrow as required for closing. The acquisition of replacement property must be completed within a total of 180 days or by the date your invoice tax return is due, whichever first occurs.

There can be seller financing in the first phase of a real estate exchange; however, it may complicate the exchange. The reason for this is that the Note and Trust Deed or the Contract of Sale will be a form of proceeds along with the cash received from the buyer. All proceeds, regardless of form, must be used to acquire the replacement property in order to defer tax.

Seller financing can be sheltered through an exchange by the paper being received in the name of the exchange company. If the seller of the relinquished property is willing to accept the paper as part of the purchase price, the exchange company will transfer it at closing. If the seller is not willing to accept the paper, it must be converted to cash (sold) and the cash used to acquire the replacement property.

The Seller financing can be excluded from the exchange. The exchange agreement between the exchanger and the exchange company may be written to exclude all or part of the paper.

That portion of the paper to be excluded from the exchange will be put in the name of the exchanger at closing. This portion of the transaction is taxable.

The accommodator receives all payments of principal and interest. Most accommodators will apply these payments at the acquisition of the replacement property. The exchanger should check with the accommodator on the subject of interest because some consider themselves entitled to interest received. Any interest earned will be taxable.

The Seller may not have financing documents put into his name and then assign them to the Accommodator. Even in the case of a vendor's interest in a contract of sale, the right to the proceeds is immediate and any monies due are not eligible for 1031 treatment.

The Accommodator may use the "Note and Trust Deed" to acquire the replacement property. The exchanger finds a seller of replacement property who will accept the note as part of the consideration to be paid. An assignment of the note is provided by the Accommodator at closing, together with any available cash.

The Accommodator may sell the paper to acquire the replacement property. The paper is either sold commercially or privately, perhaps even to the exchanger. The cash is then combined with the original cash proceeds and applied to purchase the replacement property.

Caution! Expect a discount on the sale of a note. Such discount will be influenced by the amount, terms and lien position.

A common trap to avoid is wrap around contracts and inclusive trust deeds. They present the greatest problems for an exchange. In this form of financing, an underlying financing instrument is wrapped and included within the total balance of the new instrument. This complicates the exchange because the disposition of this form of financing is so difficult.

If the paper is not sold and cannot be used to acquire the replacement property the Accommodator must assign it to the exchanger at the conclusion of the exchange. The monies due under the mortgage, trust deed or contract become "boot". The exchanger may elect to report the income from the paper on an installment basis.

What is boot? Property or other consideration not "like kind" in an exchange. Cash is not "like kind"; therefore, cash received by the taxpayer is boot. Any debt the taxpayer is relieved of, that is not replaced, can be "boot". The taxpayer may contribute additional ash to the acquisition of replacement property to offset debt relief; however, debt assumed on the replacement property will not offset cash received.

General Rule: Even or up in equity and even or up in value = full tax deferred.

Basis for identification of replacement property

Identification period begins on the date of transfer of the Relinquished Property and ends at midnight on the 45th day following the transfer of the Relinquished Property.

Form

Must be a written document, signed by the taxpayer (exchanger) and delivered to any person involved in the exchange.

American Property Exchange, Inc., provides its clients with an identification form following the transfer of the Relinquished Property. This form needs to be returned to American Property Exchange via delivery, mail or fax. Written acknowledgment of our receipt of the identification form will follow.

Content

Replacement properties must be listed by legal description, street address and city/state, or distinguishable name.

The regulations require the replacement property be unambiguously described!

Identification Rules

Exchanger must comply with ONE of the following:

3 - Property Rule
Identify three properties without regard to the fair market value of the properties.

200% Rule
Identify any number of properties as long as their aggregate fair market value does not exceed 200 percent of the aggregate fair market value of all relinquished properties.

95% Rule
Identify any number of properties without regard to value, but must receive 95 percent of the aggregate fair market value of all identified replacement properties before the end of the exchange

Following is the Life on An IRC 1031 Exchange

• Receive request for American Property Exchange to provide services, Preliminary Title Report & Earnest Money Agreement
• Prepare & Distribute: Exchange Agreement, Assignment of Seller's Position, Letter to Exchanger, and Instruction letter to Escrow
• Receive, Review & Sign Escrow Closing Documents
• Receive Proceeds & Fee Check
• Prepare & Forward Letter to Exchanger: Verification of Funds Received, 45 & 180 Day Deadlines, and Form Letter for Identification
• Receive & Acknowledge Replacement Property Identification
• Receive PTR & EMA for Replacement Property
• Prepare & Distribute: Assignment of Buyer's Position and Instruction Letter to Escrow
• Receive, Review & Sign Escrow Closing Documents
• Wire Fund Required to Escrow
• Prepare & Forward to Exchanger the State of Account and Closing Letter

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This educational series is created to allow Realtors to obtain continuing education. The articles are intended for general informational purposes and are not to be construed as legal advice or legal opinion on any specific facts or circumstances. You are advised to consult with an attorney concerning any questions about your rights or responsibilities in any specific situation.