Real estate investors may have at some point needed to use an IRS 1031 exchange to defer significant tax liability by using the sale proceeds from an investment asset deal to acquire a new one. In such a case, they’ll need a 1031 accommodator.
Choosing an exchange accommodator can be a daunting task as the IRS has specific rules you must follow, and a slight mistake can cause you to pay the tax eventually. This article explains the roles of an exchange accommodator and how to choose a good one.
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1031 Exchange Basics
Meeting the deadlines is one of the most stressful and vital aspects of 1031 exchanges. Your qualified intermediary plays a significant role in helping you submit every necessary document and meet all deadlines.
However, you’ll need to understand the following 1031 exchange basics:
45-Day Identification Period
After closing the relinquished property (the initial asset) in an exchange transaction, you’ll need to identify a replacement property (a new acquisition) to complete the exchange. This period is called the “identification period.” You must sign and deliver the documents to the entities handling your deal before the period expires after closing the relinquished asset, even if the 45th day is a weekend or holiday.
180-Day Close Period
A qualified intermediary will verify if you meet every identification requirement. After identifying your replacement asset, you’ll have a 180-day window to close on the acquisition, and these dates can’t be extended unless a natural disaster affects the assets involved.
Three Property Rule
During identification, you may find it hard to choose between several properties. You’re allowed to choose up to three assets that you plan to buy in this case. Keep in mind that you don’t have to buy all the assets — you can select one or two — but you can as well choose up to three.
200% Rule
The 200% rule is an exception to the Three Property rule. It implies that if the total value of the three properties doesn’t exceed 200% of your original asset sale value, you can choose more than three assets. For instance, if you sell a multifamily building for two million dollars, you can select more than three assets in the 1031 exchange transaction, but the combined value shouldn’t exceed four million dollars.
95% Rule
The 200% rule comes with some caveats, which is why several investors don’t identify more than three assets at a time. The caveat, popularly called the 95% rule, implies that if an individual identifies more than three assets, they must close at least 95% of the combined value within a 180-day window, or they’ll be required to pay a tax to the Internal Revenue Service. Closing multiple assets in such a time frame is often challenging for investors. Hence, they shy away from taking this route.
What Is an Exchange Accommodator and What Does it Do?
An exchange accommodator or facilitator, also referred to as a qualified intermediary, is an entity that facilitates and administers 1031 exchange services.
A reputable, qualified intermediary is vital in completing and structuring a successful 1031 exchange process, as they have the track record and expertise to help you through every step of the IRS 1031 exchange transaction. Here are some vital points to note when hiring a qualified intermediary and what they do.
Regulation, Government Oversight, and Licensing
Qualified intermediaries aren’t regulated, audited, or licensed by any regulatory or government agency, and most states don’t require them to be insured, bonded, or maintain minimum equity capitalization.
Hence, choosing an exchange accommodator regulated, audited, and licensed by a regulatory body like a financial institution regulator is essential to ensure that the exchange accommodator operates the right way.
Holding and Protecting 1031 Exchange Funds
During the sales of relinquished properties in a 1031 exchange, investors can’t access the bank account until they’ve identified the replacement property and closed the deal. The exchange accommodator is responsible for holding exchange proceeds in a top-rated FDIC-insured account.
Exchange accommodators hold the funds to prevent any actual or constructive receipt by you. Qualified intermediaries hold large amounts of IRS 1031 exchange funds for thousands of other investors like you and have a tremendous responsibility to protect these funds under their custody.
Preparing Relevant Legal Documents
A single error in the legal documentation of your 1031 exchange could lead to disallowance by the state taxing authority or Internal Revenue Service and any subsequent recognition of the capital gains tax liabilities and depreciation recapture along with penalty assessments and interest by IRS.
Qualified intermediaries prepare every required document and confirm its validity, including Sale Agreements, Assignments of Purchase, Exchange Agreements, and any other document relevant to the 1031 exchange transaction.
Two vital details to note: an exchange accommodator may be holding huge amounts of money in proceeds, so ensure that your funds are in a separate, FDIC-insured bank account.
The exchange should also have a qualified intermediary as an independent party who shouldn’t render any investment advice as it’s not their area of expertise or responsibility.
When hiring an exchange accommodator, ensure to work with an organized person who perfectly understands the process. It’ll help simplify the tax-deferred exchange process and make it more manageable for everyone involved.
Solving Conflicts-of-Interest
Ensure to avoid companies that act as qualified intermediaries and offer solutions to replacement properties. It could result in a conflict of interest or a disqualified exchange if it’s a disqualified person. Get a qualified intermediary that prioritizes your interests. You don’t want someone more concerned about getting paid and less bothered about the 1031 exchange services.
Anybody can act as your exchange accommodator. However, it’s not advisable as the person’s bankruptcy, divorce, or death may affect the 1031 transaction and compromise your 1031 exchange funds.
Ensure always to choose an experienced, institutional, and professional qualified intermediary like NNN Deal Finder that also features government oversight.
Providing Guidance
Planning and preparing for a 1031 exchange transaction can be frustrating for an investor. Imagine speaking to one exchange facilitator, getting one answer, and then speaking to another and receiving a different reply. Then, you consult with your financial, tax, and legal advisors and get three more diverse answers.
The IRS 1031 exchange industry has several grey areas due to the numerous unanswered questions in the Internal Revenue Code (IRC section 1031) and Treasury Regulations (Section 1.1031). That’s why you may receive several different answers (which represent individual opinions and not really answers).
Hence, the most crucial role of the exchange facilitator is to help a taxpayer solve the 1031 transaction mystery by using well-trained, professional 1031 exchange administrators. Thus, ensure that they have the right expertise to offer the necessary guidance and advisory services to help you unravel the mysteries within the 1031 exchange industry.
Disqualified Persons Can’t Serve as a Qualified Intermediary
Not everyone can serve as your exchange accommodator. You’re not allowed to serve as your company’s or personal qualified intermediary. Your accountant, attorney, securities broker, real estate agent or broker, or a disqualified person under Section 707 (b) and 267 (b) of the (Internal Revenue Code) can’t be your qualified intermediary.
Common Types of 1031 Exchanges
Delayed Exchange
The most common type of 1031 exchange among investors is the delayed exchange, and it involves the exchanger relinquishing the original asset before acquiring another one. In other words, a taxpayer must complete their asset exchange transaction first, and use the proceeds from the deal to fund the replacement asset.
You’ll need to complete a sale/purchase agreement and exchange agreements to start the delayed exchange transaction. After doing this, an escrow company will initiate the relinquished asset deal and keep the proceeds in a trust for 180 days as the seller searches for a like-kind asset.
The delayed exchange allows an investor to identify a new rental asset within 45 days and sell your asset within 180 days. Besides the several tax benefits, the extended timeframe is among the top reasons for the popularity of the delayed exchange.
Simultaneous Exchange
This type of exchange occurs when the sales of both relinquished and replacement properties are closed on the same day. A simultaneous exchange can occur in three general ways:
- A simultaneous exchange that involves qualified intermediary handling the entire exchange
- Complete a three-party trade, which involves an “accommodating party” who facilitates a simultaneous transaction
- A two-party exchange, where two parties “swap” or exchange deeds
Reverse Exchange
This form of exchange involves buying the replacement asset via an exchange titleholder before exchanging your investment. You can also refer to this form of exchange as “buy first, and exchange later.”
Note that reverse exchanges aren’t the most common since they require cash. Most banks won’t provide loans for a reverse 1031 exchange. Every taxpayer needs to select the investment properties to use for the exchange. You risk forfeiting the exchange if you fail to complete the relinquished asset deal during the 180-day window. There are two significant differences:
- 180-day window (including the 45-day identification period) to close the identified asset deal and the reverse exchange by buying the replacement asset
- 45-day window to identify a relinquished asset
Improvement or Construction Exchange
This exchange allows an asset owner to update the replacement asset using tax-deferred money while the qualified intermediary holds it until the 180-day window elapses.
If they wish to defer the gain (from the relinquished asset sales) and use it for the improvement or construction exchange, they must meet these three requirements:
- The updates must have been completed before the taxpayer takes the title from the exchange accommodator
- You must spend the exchange equity as a down payment or complete improvements by the 180th day
- The value of the replacement asset must be greater or equal when it’s deeded to the taxpayer
- The taxpayer must get substantially the same asset identified by the 45th (final) day
Reasons to Choose 1031 Exchange
Several US citizens show interest in 1031 exchanges due to its numerous benefits. The 1031 exchange allows them to make tax-deferred exchanges for their properties. Here are some of the key reasons to choose the 1031 exchange.
Tax Deferral Opportunities
Deferring tax is the ideal reason for opting for 1031 exchange. The list of benefits include the Affordable Care Act, depreciation recapture, capital gain tax and several others, depending on your place of residence and several other factors. Deferring these taxes is possible with this exchange.
No Limits
The 1031 deal doesn’t have any particular limit, as you can sell your assets and get the offer. That way, you can invest in larger assets without having to pay tax for it too.
High Cash Flow
The 1031 transaction enables a high cash flow. From survey and calculation, the capital gains tax value is generally higher than the asset you acquire with 1031 exchange. The 1031 deal is better than capital gain tax for those expecting long term yields with their purchases.
Complete 1031 Exchange Roadmap From NNN Deal Finder
Before starting the 1031 exchange process, you’ll first need to understand how the IRS Section 1031 code works. It’s essential to get deeper insights to ensure a well-structured exchange. The following are reasons to allow NNN Deal Finder to handle your exchange process:
Timing Is Everything
The process is as important as the properties. Ensure to properly time each phase of your transaction to prevent buying properties you don’t need. We offer our numerous clients the best services while also showing you the safest methods to execute each task.
Know the NNN Market Traps
Several NNN properties are available on the market, and finding the ideal replacement isn’t as easy as imagined. We can show you how to avoid the traps and also provide the crucial questions to ask to keep your money safe.
Understand the NNN Market
Ensure to settle your investment criteria in advance of your relinquished asset deal. With numerous assets on the market, you’ll need a framework to evaluate your options and know what’s best for you.
Perform Due Diligence
Ensure to perform your due diligence by proactively engaging in investigations, so you don’t buy an undesirable asset. We also perform due diligence to show why you need to exercise restraint before your 45-day identification period expires.
Exchange Consummation
Effectively monitoring each step of the process is often multifaceted and overwhelming. However, you can learn the organizational strategy necessary to position yourself for a seamless and full-informed closing.
Ready to Start Your Own 1031 Exchange Way?
If you’re looking to defer tax liabilities by using the proceeds from the sale of your asset to acquire a new one, contact NNN Deal Finder. You’ll be properly guided through the necessary documentation and details you need for a successful 1031 transaction.
