Functionally, a 1031 exchange is like a normal real estate sale with one huge exception, and that is that the proceeds of your sale are to go to an exchange accommodator.
It was always best to plan and to inform your listing agent that you will be completing a 1031 exchange. If you’re not using a real estate agent, you must let the buyer of your property know
that you intend to complete a 1031 exchange. A cooperation clause should be included in any purchase and sale agreement, or if not included, your escrow instructions must be
amended to include the cooperation clause naming the specific qualified intermediary you will be using and informing escrow that there will be no cost to the buyer.
When your property is on the market for sale, or after you open an escrow, you select a qualified intermediary, an exchange accommodator, and open an account with that
company. Then, you would provide your exchange accommodator with complete contact information for the escrow company. If you are going to be drawing cash from your exchange, that
must also be specified in your escrow instructions, and it is best to inform the exchange accommodator.
The cooperation clause in your escrow instructions informs the buyer that they are to cooperate with your 1031 exchange at no cost to them and, at the same time, specifies the qualified
intermediary that you have selected to receive the proceeds of your sale.
This step is required to qualify as a 1031 exchange and not a sale for Federal tax purposes.
After selling your relinquished property, also known as the down-leg property, the beach was sent to your exchange accommodator.
At the close of escrow, your 45-day identification period starts. Within 45 days of the sale of your own leg (relinquished) property sale, you are to choose your replacement properties using one of
the three identification rules. If you do not close within that 45-day window, you must, in writing, provide your exchange accommodator with a list of properties that you will select from to complete your 1031 exchange. Note that most exchange accommodations require identification of the percentage of ownership of a replacement property if it is less than 100%.
For example, if you want to invest $1 million in a large investment-grade property, you would identify your percentage ownership and the value of your percentage of the property.
Once you reach 11:59 PM on the 45th day, you may not change the list of identified properties, and you must close on one (or more) of those identified properties. Failure to do so will disqualify your attempted exchange, and you will have what’s known as a failed exchange and create tax liability for yourself.
For example, with DSTs, you can identify a percentage of a property with as little as a $100,000 equity investment.
If you purchase one or many DSTs, you sign a purchase agreement(s) and a questionnaire(s). The purchase agreement, as it states, is similar to a regular real estate
purchase agreement; however, the purchase questionnaire has information that is required to identify you and document that you are what’s known as an accredited investor. See the separate
blog post regarding accredited investors or the FAQ for definition. Once you have signed the purchase agreement, it will be sent to your exchange accommodator. The exchange accommodator
verifies the information and contacts you for authorization to make a purchase. At that point, the exchange accommodator provides a form authorizing the purchase for your benefit, and you sign an acknowledgment that the accommodator is not a party to the transaction.
Once that happens, the exchange accommodator can quickly wire the funds to the property, and the actual closing happens on or about the date that the funds are wired to the DST or if purchasing a non-syndicated property, the funds are wired to the appropriate escrow company.
1031 Risk Disclosure:
· There is no guarantee that any strategy will be successful or achieve investment objectives;
· Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments;
· Change of tax status – Any investment property’s income stream and depreciation schedule may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may
cancel deferral of capital gains and result in immediate tax liabilities;
· Potential for foreclosure – All financed real estate investments have the potential for foreclosure;
· Illiquidity – Because 1031 exchanges are commonly oƯered through private placement oƯerings and are illiquid securities. There is no secondary market for these investments.
· Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage; there is potential for
suspension of cash flow distributions;
· Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits
General Disclosure
Not an oƯer to buy, nor a solicitation to sell securities. All investing involves the risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional before investing. Any information provided is for informational purposes
only.
Securities through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not aƯiliated with any other entities
identified in this communication.
For more information on Emerson Equity, please visit FINRA’s BrokerCheck website. You can also download a copy of Emerson Equity’s Customer Relationship Summary to learn more about their role and services.