Call in Advance
(“Exchangor" or "Exchanger") Individual or entity desiring an exchange.
s often lose opportunities for 1031 tax deferred exchanges simply by not being informed and planning ahead. We frequently receive calls from a taxpayers who have already sold the relinquished property and would now like to exchange it for a replacement property. Often they still hold the proceeds check and have not deposited it, erroneously thinking that depositing the funds would be the factor that would invalidate an exchange. Unfortunately for several reasons, it's too late to enable the taxpayer to complete the exchange.
First, once the title company issues a check made out to the taxpayer, that person is in "actual receipt" of the funds. The IRS regulations provide any attempt at an exchange is not valid if the taxpayer has any "rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property" pertaining to the sale proceeds. So the error of failing to contact the exchange company until immediately after the sale of the relinquished property would disqualify any exchange attempt.
Even if the taxpayer were to return the check to the title company in exchange for a check made payable to the qualified intermediary, the taxpayer still could not qualify for an exchange. Under the regulations, the taxpayer needs to assign certain contract rights that he or she has under the relinquished property contract to the qualified intermediary no later than the day of closing. Further, the notice of this assignment is also required to be given to the relinquished property buyer. Failure by the taxpayer to assign the contract rights and notify the buyer of that assignment on a timely basis would, by itself, prevent any attempt at a deferred exchange.
These delays in getting the exchange company involved often take place in connection with reverse exchanges. A reverse exchange occurs when the taxpayer needs to close on the acquisition of the replacement property prior to the disposition of the relinquished property. This is sometimes referred to as a pure reverse exchange. The IRS does not recognize the validity of a pure reverse exchange. Had a taxpayer facing the acquisition of the new property before the sale of the old property called the exchange company prior to the acquisition of the new property, it would have been fairly simple to structure the transaction to qualify for tax deferral. This would involve the exchange company taking title to the new property on the date of closing and holding it for the benefit of the taxpayer until immediately after the sale of the relinquished property. At that time the exchange company would transfer the property to the client. Had a phone call been made to the exchange company a few days or more before the closing on the replacement property, there would have been time to structure the transaction to fit the IRS rules.
In short, there are a myriad of rules and procedures that need to be adhered to in order to structure a successful deferred exchange. Section 1031 is much form over substance and there are many ways for an exchange to get tripped up. First and foremost of these is failure to call the qualified intermediary well before the sale transaction is to take place to make sure all necessary documents are in place and that they are signed by the necessary parties. Maintaining close contact with the exchange company, can help the taxpayer navigate the safe harbors.
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