Tax-deferred exchanges are a way for people who want to invest in real estate to exchange one property (the relinquished property) for another property (the replacement property) and take advantage of 1031 exchange benefits such as leverage, consolidation/diversification, management relief and increased cash flow/income. To understand all the details and requirements, it is recommended that the individual who is interested in a tax-deferred exchange consult a tax or legal adviser about specific circumstances.

According to First American Exchange, a Qualified Intermediary, timelines and identification requirements can be confusing to the neophyte investor. That's why it's also a good idea to work with a Qualified Intermediary company that understands the process and can explain the details.

For instance, as part of the identification process, investors or Exchangers must identify the property they wish to acquire within 45 days of the transfer of the relinquished property in a written document signed by the Exchanger. The Qualified Intermediary usually proves an Identification Notice for this purpose.

The Identification Notice must be hand-delivered, mailed, telecopied, or otherwise sent to the person obligated to transfer the replacement property to the taxpayer (such as the seller of the replacement property) or to any other person involved in the exchange (such as the Qualified Intermediary, escrow agent or title company), other than a disqualified person (such as agents of family members of the Exchanger). Most Identification Notices are sent to and kept by the Qualified Intermediary.

Potential replacement properties must be described by street address, legal description, assessor's parcel number or distinguishable name in an unambiguous manner. As an example, if the property has a unit number, it is important that the specific number be identified so that the Exchanger does not mistakenly identify an entire subdivision or complex. Similarly, if the property being acquired is a tenancy-in-common interest, the Exchanger must identify the percentage interest he will receive in the exchange, not the entire property.

The Treasury Regulations mandate that an Exchanger receive substantially the same property as identified. An example in the Regulations indicates that the rule will be met if an Exchanger acquires at least 75 percent of the value of the property identified. If the replacement property is under construction at the time of identification, it may be advantageous to list the intended improvements on the Identification Form to ensure compliance with this rule.

An Exchanger may sell and buy as many properties as desired in a 1031 exchange, subject to certain identification rules, including the Three Property Rule, the 200 Percent Rule and the 95 Percent Rule.

An Exchanger may identify up to three properties, without regard to the fair-market value of those properties. An Exchanger may alternately identify an unlimited number of replacement properties, if the total fair-market value of all the properties is not more than twice the value of the relinquished property or 200 percent of the relinquished property. If the Exchanger wishes to list more than three possible replacement properties and cannot meet the 200 Percent Rule, the Exchanger may do so only if 95 percent of the value of all properties identified is received.

The Three Property Rule is the rule employed in the majority of cases, since most investors do not intend to acquire more than three properties, and because the other two rules are sometimes difficult to satisfy. During the course of the 45 days, an Exchanger may revoke his Identification Form and submit a new one as many times as he likes, but after the 45th day, any properties acquired must be listed on the most current Identification Form.

If the Exchanger plans to sell more than one property under one exchange, the 45/180 day timelines will begin to run from the date the first relinquished property closes. Since the timelines do not start to run until the relinquished property is actually transferred, an Exchanger may try to negotiate a longer close-of-escrow date on the relinquished property if he needs more time to identify replacement property.

An Exchanger will always have 180 days to acquire the replacement property, but for exchanges that close between Oct. 18 and Dec. 31 of any non-leap year, a tax-filing extension may be necessary to ensure that the full 180 days is received. Once the relinquished property closes, an Exchanger should never file his tax return before acquiring the replacement property, and when an extension is requested, it is imperative that the estimated tax amount be included.

Thorough documentation is crucial to prove that the exchange timelines and identification requirements are met. It's important to not only consult a tax or legal adviser about 1031 Qualified Exchanges but to also work with a Qualified Intermediary who understands this process is of the utmost importance for a successful transaction.

For more information about 1031 tax-deferred exchanges, contact Debbie Culbertson at First American Exchange at 800.833.4343.