Monday, March 9, 2009

1031 Tax Free Exchange - A Pratical Guide

In earlier postings I laid out the statutory workings of a 1031 Tax Free Exchange (aka Like Kind Exchanges). Having assisted my clients in completing several of these, I want to tell you in piratical terms how it happens.

The key to remember is that time (days) is always of the essence.

Generally, my client that ends-up completing a 1031 Exchange has a parcel of real property for sale. Before we even have an offer, I ask my client what they want to do with the money. And to be straight with you, I don't really need to know what they are going to do, but I do want them thinking about it.

In coming to the decision of what they want to do [and why, as I discussed in earlier postings], it will benefit them to know as soon as possible if they are going to be looking for a 1031 Exchange Property (or Replacement Property), because they will also need to decide what type of property they will want. No surprising, my clients like things like, commercial sites, industrial buildings, ranches and income producing properties. These type of properties take time to find and view.

As an example, on a good day you can see three ranches but two or even one are the norm. And Texas is a big place, do you want an Central Texas Ranch, South Texas Ranch or well, like I said, Texas is a big place. For that matter, the United States is a big place, because any property in the U.S. is suitable exchange property.

Do you want to buy a Burger King in Amarillo or an Auto Zone in Georgetown? What is the cap rate? How long is the remaining lease. All important things to consider.

So lets get started, we just received a contract on your parcel and a 1031 Exchange is what you want. We contact the Qualified Intermediaries [QI] and get conformable with one. We then let the title company [or the closing attorney] know to send the closing proceeds to the QI [remember, the key here is that the proceeds stay out of your possession]. Once your property closes, we have 45 days to identify three potential properties. The Sellers of these properties don't need to know that you have 1031 money and that their property is one of the three you've chosen and in fact, in terms of negotiating, it is better if they don't.

Once identified, you have 180 days [most likely less because you've spent some of this time identifying potential properties] from the date of Closing to negotiate, contract and close your replacement property. When you consider negotiation time, feasibility periods, surveys and the other numerous elements it takes to buy non-residential property, that is a really really tight schedule. Even once you agree to terms with the Seller, they may not be able to close in a timely manner to fit your 1031 timetables and you have to keep looking.

Once you get your exchange property under contract, you'll tell your QI, with the proceeds they are holding, to place the earnest money into escrow for the new purchase. Then presuming you elect to close the property during your feasibility period, you'll instruct your QI to send/wire the funds to buy the property on the scheduled closing date [presumably within 180 days of closing].

There, done. You have your replacement property.

With my clients I take a all hands on deck approach. Even when they are knowledgeable enough to go through the 1031 process by themselves, they're going to need all the help they can find. I use my experience and contacts to identify and find potential replacement properties. I have a lot of clients with different abilities, but generally I am in a much much better position to do this than my clients. It takes time and effort, but this is exactly what they are counting on me for. When my clients go in the 1031 clock, I go on the 1031 clock.

Many times I am the one viewing the properties when my client can't make it. I evaluate it and report back to my client. I also help in the feasibility process. Often I am more familiar with what questions are prudent to have answered during the feasibility period. I have professional relationships with engineers, architects and environmental specialist that I can a call upon to ensure my client gets drawings or reports timely.

I suggest when completing a 1031 Exchange to enlist an experienced commercial real estate broker. I know that I have at all times a working knowledge of what properties are on the market [and some that are not, but can still be bought]. I also have an open line of communication with my fellow brokers. I often can get information more timely from them than my clients can by going directly to them. Also know that most Buyer's Brokers are compensated by the Seller, mean that they are more or less paying for my services, which most of my clients think is a real benefit.

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