Let’s walk through the step by step process for carrying out a 1031 exchange. Be aware that the following is just a general outline, so specific deals will likely vary slightly from this process.
The 10-Step Process to Perform a 1031 Exchange
1. Decide to sell and do a 1031 exchange.
Not every purchase is worth doing a 1031 exchange. After all, with all the requirements, costs, and countdown timers, simply paying the tax and moving on may be advantageous. That is definitely a discussion for you to have with your accountant.
2. List your property for sale.
You then list your property for sale, as you ordinarily would. Your agent will likely include language in the listing paperwork regarding your desire to do a 1031 exchange and the buyer’s needed willingness to play along.
3. Begin looking for replacement properties.
Remember, the moment the relinquished property is sold, the 45-day countdown begins. Therefore, you should begin looking for deals immediately.
4. Find a qualified intermediary.
Look for someone professional with a good reputation.
5. Negotiate and accept an offer.
When someone agrees to buy your property, you will need to make sure the paperwork clearly states that a 1031 exchange is taking place on your end, and the buyer will need to comply. Although the buyer does not need to do a lot of work, they may need to sign off on certain paperwork, such as assignments or disclosures.
6. Close on the sale of your relinquished property.
The title company or attorney will handle the closing, as with any other real estate transaction, except that your qualified intermediary will be actively involved in the process, and the funds will transfer to their bank account, not yours.
7. Identify up to three properties within 45 days.
Now is the time to officially designate the properties you might pursue. Keep in mind, you can identify up to three properties, or more if you close on 95% of them or the total combined value of the identified properties is less than 200% of the sales price of your relinquished property.
8. Sign a contract on the first-choice property.
Most likely, of the three properties you identify, one will stand out as your first choice. You will need to get that property under contract and open escrow, making sure the seller knows you are purchasing through a 1031 exchange. You could also go under contract on all three of your identified properties, using contingency clauses to back out on the ones you later decide not to pursue.
9. Let your qualified intermediary work with the title company.
You, your agent, and your qualified intermediary will work with the title company or closing attorney to make sure to dot all the Is and cross all the Ts. This is actually a fairly simple process, one that your qualified intermediary should be familiar.
10. Close on the replacement property.
Finally, the qualified intermediary will wire your money over to the title company or attorney, and the property will close as in a normal transaction, deferring your need to pay the taxes until some point in the future, if ever. (I’ll talk about the “end game” in a moment.) The beauty of the 1031 exchange is that you can repeat this process over and over again on properties and continue deferring taxes indefinitely. This can help you build some serious wealth over time, greater than if you simply paid the taxes each time.
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