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Delayed Exchange

The most commonly utilized tax planning strategy available to investors is the delayed exchange. A delayed exchange results when there is a time delay between the sale of the relinquished property and the purchase of the replacement property. Also referred to as a "Starker Exchange" because of the landmark 1979 federal case entitled, Starker v. U.S. 602 F2d 1341 (9th Cir 1979) wherein the court substantiated the validity of the delayed exchange process. Prior to the Starker case, 1031 of the Internal Revenue Code (promulgated in 1924) authorized tax-free exchanges of real and personal property. Thereafter, Congress, in the 1984 Tax Reform Act, adopted subsection 1031(a)(3) which created the 45 day identification period and the 180 day exchange period. Finally, on April 25, 1991, the IRS promulgated the final regulations under section 1.1031(a)-1, et. seq. which provide specific rules for deferred like kind exchanges. Personal property is no longer eligible for 1031 exchanges, effective January 1, 2018.

The delayed exchange provides investors up to 180 days to purchase replacement property once the relinquished property is sold. And, the use of a Qualified Intermediary is required to facilitate a valid delayed exchange. The delayed exchange occurs in three fundamental steps:

STEP ONE: Sale of the Relinquished Property: Before closing on the sale of the relinquished property the Exchanger retains a Qualified Intermediary such as Old Republic Exchange. Old Republic Exchange prepares an exchange agreement, assignment of sale contact and closing instructions to the escrow/closing agent. Old Republic Exchange instructs the escrow/closing agent to direct deed the relinquished property to the buyer and to deliver sale proceeds directly to Old Republic Exchange - thereby preventing the Exchanger from having actual or constructive receipt of the funds. Once the funds are delivered to Old Republic Exchange, access to the funds is restricted for the remainder of the exchange period. In short, IRC 1031 provides strict rules pertaining to the release of funds to the Exchanger even where the Exchanger decides not to proceed with the exchange.

STEP TWO: Identification of the Replacement Property: The Exchanger must identify replacement property within 45 calendar days of the close of the relinquished property. The identification is proper only if the replacement property is designated as replacement property in a written document signed by the Exchanger and hand delivered, mailed, telecopied, or otherwise sent to the person obligated to transfer the replacement property to the Exchanger (i.e. the seller of the replacement property) or to any other person involved in the exchange other than the Exchanger or a disqualified person. Three identification rules apply:

  • 3 PROPERTY RULE: Three properties no matter what the fair market value; or
  • 200 PERCENT RULE: Any number of properties as long as the aggregate fair market value does not exceed 200% (2x) of the fair market value of all the relinquished properties; or
  • 95 PERCENT RULE: Any number of properties without regard to value - provided 95% of the value of the identified properties are acquired.

STEP THREE: Purchase of Replacement Property: Within 180 calendar days from the sale of the relinquished property, or the Exchanger's tax filing date (assuming no automatic extension is applied for), whichever is earlier, the Exchanger must acquire like kind replacement property and the property acquired must be one or all of the previously "identified" replacement properties. The Exchanger again assigns the purchase and sale contract to Old Republic Exchange, who purchases the replacement property with the exchange proceeds and causes the transfer of the replacement property to the Exchanger by way of a direct deed from the seller.

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