For various reasons, investors may want to sell their interest in a residential real property and invest their funds in new property. At the same time, they prefer to remain fully invested and want to defer the payment of capital gains tax on the gain in equity accrued during their ownership. This note is intended to give a real estate investor a brief overview of the requirements necessary to accomplish such a tax-deferred exchange; however, the process is inherently a legal one and competent legal counsel should be consulted before entering into such a transaction. Upon request, Key Title can assist you by referral to appropriate legal and accounting professionals who can manage your transaction. This overview is not intended to be a substitute for the advice of an attorney or tax-specialist.

What is a Tax-Deferred Exchange?

The procedure authorized under Section 1031 of the Internal Revenue Code is a mechanism for the sale of existing investment real estate and the acquisition of replacement investment real estate in order to defer payment of capital gain income tax. Note: This procedure is often incorrectly referred to as a "Tax-Free Exchange" which it is not. Any tax due is not eliminated--only deferred--until the replacement property, or any subsequent replacement for it, is sold at which time an accounting is made to determine the investor's tax liability.

What Are Some of the Essentials?

• The property being sold (Existing Property) and the property being purchased (Replacement Property) must be investment property and not the investor's primary residence or second home.

• The net proceeds from the sale must be totally reinvested into the Replacement Property. The total mortgage debt on the Replacement Property must be equal to or greater than the mortgage debt on the property which is being sold.

• The seller of the Existing Property must be the same as the purchaser of the Replacement Property, i.e. cannot sell as a partnership and purchase as an individual investor.

• The intent to do an exchange should be included in the real estate listing and must be evidenced in the sales contract.

• The Replacement Property must be identified no later than 45 days after settlement on the Existing Property.

• The Replacement property must be settled no later than 180 days after settlement on the Existing Property.

How Does it Work?

• The investor seller expresses the intent to utilize this provision to the listing agent and this is put in the listing. The sales contract will include specific language evidencing the purchaser's agreement to cooperate in a 1031 Exchange.

• An Exchange Agent (also known as a "Qualified Intermediary" or "Third-party Accommodator) is identified to facilitate the sales/purchase transactions and hold all proceeds of the sale of the Existing Property until they are reinvested in the Replacement Property.

• A law firm will draw up all necessary contracts, addendums and other necessary paperwork to effect the 1031 Exchange.

• The settlement of the sale of the Existing Property is conducted by KeyTitle and proceeds transferred to the Exchange Agent. Sales proceeds are held in an interest bearing account accruing to the benefit of the investor.

• The investor identifies the Replacement Property no later than 45 days after the settlement of the existing property. (The best manner of identification is a ratified sales contract.) Up to three replacement properties may be identified if the investor is uncertain of the specific Replacement Property. Note: While Replacement Property may be identified prior to settlement of the Existing Property, the Replacement Property should not settle first without establishing a reverse Starker exchange. Note: A reverse Starker exchange is both extremely complicated and costly

• The Replacement Property is settled and title is transferred to the investor.

What Does it Cost?

The purchaser of the Existing Property, incurs no additional costs for cooperating with the investor in effecting the 1031 Exchange. However, in addition to the normal settlement costs, the investor will incur the following costs:

• A law firm will charge for preparation of papers for the basic two property exchanges.

• A title company will charge a fee for acting as the Exchange Agent/ Third-Party Accommodator/Qualified Intermediary.