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A General Guide to Tax Deferred Exchanges
By: P. Patrick Ashouri, Esq.
Time Requirements
The Exchangor has a maximum of 180 days from the closing
of the relinquished property or the due date of that year's
tax return, whichever occurs first, to acquire the replacement
property. This is called the Acquisition Period. The first
45 days of that period is called the Identification Period.
During this 45 days, the Exchangor must identify the candidate
or target property which will be used for replacement. The
identification must:
- Be in writing,
- Signed by the Exchangor, and,
- Received by the facilitator or other qualified party
(faxed, postmarked or otherwise identifiably transmitted through
Federal Express or other dated courier service).
- This must all occur within the 45 day period. Failure
to accomplish this identification will cause the exchange
to fail.
Identification
Three rules exist for the correct identification of replacement
properties.
- The Three Property Rule dictates that the Exchangor may
identify three properties of any value, one or more of which
must be acquired within the 180 Day Acquisition Period.
- The Two Hundred Percent Rule dictates that if four or
more properties are identified, the aggregate market value
of all properties may not exceed 200% of the value of the
relinquished property.
- The Ninety-five Percent Exception dictates that in the
event the other rules do not apply, if the replacement properties
acquired represent at least 95% of the aggregate value of
properties identified, the exchange will still qualify.
As a caveat it should be mentioned that these identification
rules are absolutely critical to any exchange. No deviation
is possible and the Internal Revenue Service will grant no
extensions.
Ironically, although only approximately 3-5 percent of exchanges
are audited, the few exchanges which don't pass upon audit,
typically they fail because of discrepancies in identification.
Mechanics of a Delayed Exchange
It is important that any exchange be carefully planned with
the help of an experienced, competent and creative exchange
professional. Preferably one who is completely familiar with
the tax code in general, not just Section 1031, and who has
extensive experience in doing many different kinds of exchanges.
Thorough planning can help avoid many subtle exchanging pitfalls
and also ensure that the Exchangor will accomplish the goals
which the transaction is intended to facilitate.
Once the planning is complete, the exchange structure and
timing are decided, and the relinquished property is sold
and the transaction is closed, the facilitator becomes the
repository for the proceeds of the sale. The money is kept
in the facilitator's secured account until the replacement
property is located and instructions are received to fund
the replacement property purchase. The funds are wired or
sent to the closing entity in the most appropriate and expeditious
manner, and the replacement property is purchased and deeded
directly to the Exchangor. All the necessary documentation
to clearly memorialize the transaction as an exchange is provided
by the facilitator, such as exchange agreement, assignment
agreement and appropriate closing instructions.
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