The 1031 Exchange Getting Started Checklist – Everything to Know For a Successful Transaction

Hello, David Moore, Equity Advantage, 1031Exchange.com, and we’re going to talk about getting started with an Exchange today. Remember, the biggest thing with any Exchange is there’s got to be an Exchange. Something’s going to be given away and something’s got to be received. If you have a transaction where you have actual or constructive receipt of funds, you’ve got tax exposure, so what’s actual or constructive receipt mean?

Well, actual, obviously, you’ve got the money in the bank or whatever might be the case. Constructive receipt means you close the deal, the check’s sitting there with escrow, you never touched it, and you think, “Well, gee, I never touched it, I’m fine.” No, you have constructive receipt and it’s too late to do the Exchange.

So we’ve got a situation in today’s world where people ask all the time, “When would I like to hear about an Exchange?” Or, “When I would like the tax payer to think about an Exchange?” I’m going to say when they buy the property. Unfortunately, that doesn’t happen very often. But the reason I say when you buy it is because there’s different ways to own an asset, and depending on how you own the asset, you’re probably going to sell it at some point, and it’s going to impact how you can dispose of it in the future.

So an example of that might be, let’s say you, me, and your brother Tim, together, the three of us go buy a property and we create a limited liability company to own that property. Do you think the three of us are going to want to own it together in five or 10 years? Probably not. Or what if just one of us wants to go away, you’re tired of me and say, “Hey David, we’re done with you. Go buy something else. We’re going to buy you out.”

Well, to buy me out, I’ve got to drop my interest if I want to do an Exchange and do a tenancy in common with that limited liability company, and then I need to have an appropriate seasoning period before between that disposition, distribution and ultimate sale, because if it’s just distributed immediately sold, I never held my interest personally as investment, so that’s where that problem is, that’s where continuity of investing gets to be such a big issue is because partnerships, partnership interests are specifically prohibited from 1031 treatment. So it takes time, it takes planning.

So that’s just one example of why I’d like you to think about it when you buy the asset, but when you consider a sale at that point, the first thing I’d like to see you do is talk to your tax people and understand what the tax liability is going to be, if you just sell the property, obviously there’s not much tax liability or maybe you have losses elsewhere to offset the gains, don’t do the Exchange, especially in an overheated market like we’re in right now.

So I want to say this, having tax exposure is one thing, taxes actually due is quite another, so triggering tax on the disposition of property, you just need to understand what that liability is going to be and what the ultimate liability is, because we’re sitting here in July of 2022, the stock markets had some adjustments in the last few months. You might sell your property and realize gains, but you might have some losses somewhere else to offset those gains and it can all work out.

Now, I’ll warn you that if your a stock market investments are all on IRAs and 401Ks, those things, even though you had a tremendous haircut in value there, they’re not going to be losses, you’ve got anything that’s in that retirement account, you just got to balance that goes up or down, you pay tax on the money when it comes out as normal income tax, unless it’s Roth IRA funds and it’s different.

Have great tax people, great tax people, the most important people in your life. You’re your tax people crank the numbers on a future disposition before it happens, don’t wait till its closing, understand what your obligation is going to be if the thing goes away sooner rather than later. That way you can make the intelligent decision whether you want to do an Exchange.

Anybody on this video that’s done an Exchange will tell you the time is the biggest problem, especially in a market like we’ve had the last few years, where you’ve only got 45 days to ID things through 1031, a total of 180 days to get it done that 180 is rarely a problem right now. It’s that 45 days because things go on the market, get bid up like crazy and disappear, nobody’s willing to wait out all. There’s no contingent offers in today’s world, everything just sort of happens, you might have an offering back, five back up offers, it’s changing a little bit in July once again, but it’s still a pretty frantic market, so timing the deals is critical.

So as far as when to think about that transaction, you want to make sure you ideally, when you buy it, if you haven’t done it then before you ever dispose of anything before you go to market, where… I think about it then. Now, the issue that comes up is a lot of states now on the Broker’s Association of Realtors forms, will have boilerplate verbiage in there that establish your ability to do an Exchange. It’ll say something along the lines of buyer seller reserves the right of the option to do an Exchange. It’s great because at the 11th hour, you could elect to do an Exchange and there’s nothing in the contract that needs to be changed that would prohibit you from doing it, right?

The downside of relying on that boiler plate is nobody’s telling escrow. You’re going to do an Exchange, so you could have all the intent in the world to do the transaction and it gets closed without that done because nobody told them. Nobody made a point blank, clear, this has got to be a sale as an Exchange. So, if you’ve got a property that you’re selling, ideally, you’re going to put something in there. If you want to do an Exchange, put it in there as additional contingencies or addendum stating that your intent is to do a 1031 tax deferred Exchange.

It could be as simple as seller, seller intends to do a 1031 tax deferred Exchange, no additional cost or obligation or liability to buy or something along those lines is going to be totally fine. And we’ll establish in your intent and let escrow know you’re going to do it, let your broker know you’re going to do it that way, it can’t get closed without the Exchange being set up, because even though 1031 is over 100 years old at this point, the number of calls we get maybe a day after closing or five days after closing, it’s just… It’s a sad deal because people think, “Well, gee, I wanted to do this,” and it’s too late.

Now, if you called us and gave us the information a couple of days ahead of time, or even a day ahead of time sometimes, we can get the deals together, but you’re going to have additional cost just because of the rush that’s involved, and you’re going to probably have unhappy escrow officer. So, we want you to be ready for these things sooner rather than later. If you’re working with equity advantage on a 1031, we do not have a cancellation fee, if you cancel before the closing. So, there’s really no reason to wait until the 11th hour to put the Exchange together, you can call us up.

We’ll put the deal together, it’ll be ready for you when you get to close and you’ll have everything in advance to review and you’ll be comforted in the fact that you’ve got copies to review and you know it’s done and everything’s set to go, but do not sign paperwork, if you want to do an Exchange, do not sign paperwork at closing, no settlement statements, if they do not include anything with respect to the 1031.

So how does a settlement statement look different in an Exchange than it would in a normal sale? In a normal sale, you’re going to sign everything as the seller, while in an Exchange, you’re going to sign things read and approved as the Exchanger, we actually sign as the seller. The assignment agreement we put together for the Exchange allows us to step in and assume all rights and obligations of you as a seller of the relinquished property and buyer of the replacement property.

So on that sale, the settlement statement is going to show equity advantage as a seller, you’re going to sign as the Exchanger read and approved, the deed actually goes straight from you to the buyer and on the acquisition side straight from the seller to you. And this is assuming the deal is a basic delayed Exchange, not a reverse Exchange where we’re actually taking ownership of stuff or an improvement Exchange where we’re taking ownership.

So once again, those settlement statements, if they don’t show Exchange verbiage, if they don’t show that that Exchange has been structured, and if that money appears to be going to you, if the sales proceeds are going to you… It’s a problem, do not sign the settlement statements step away, say, “Hey, you know, I don’t see the paperwork for the Exchange company, I want to do this,” and just refuse to sign the stuff until it’s set up, bottom line, because if you sign it, it cannot be fixed later.

So once again, think about the transaction, when you buy it, worst case, think about when you’re going to sell it and let your broker know that’s what you want to do, negotiate the sale as you normally would. As soon as escrow is opened up, contact the Exchange company, and really all we need is contact information, taxpayer’s name, address, phone number, and email address along with the escrow officer’s name, escrow number, and a phone number, if you don’t have an escrow number it could be the property address and buyer’s name too.

And then we’ll reach out to escrow and get what we need to put the deal together, and you’ll be set up at close, but it’s been such a crazy world the last few years, I know people get behind the eight ball, and you just need to slow down and make sure things are set, so I hope this has helped. Once again, David Moore, Equity Advantage, 1031Exchange.com. Thank you for your time. Take care, bye bye.