The tax benefits associated with 1031 exchanges have been around for decades. Selling one property and turning around those proceeds to purchase another, similar property has been a way of deferring the capital gains tax for many people over many years. When the rules were first set that allowed this type of exchange, they applied to transactions that happened serially, meaning that a property had to be sold before the replacement property was purchased.
This proved somewhat difficult for many property owners, because the tight timelines associated with transaction – closing on the acquired property had to occur within 180 days – meant that there often was not sufficient time to take advantage of the opportunities. (Those properties had to be identified within 45 days of the close).
But this changed in 2000, when Congress approved what’s referred to as a Reverse Stalker Exchange, which allows people to purchase the replacement property first and then sale the existing property. This change in the rules has opened the door for many more to participate in the tax advantages inherent in 1031 exchanges.
Qualified Intermediaries are required
In order to do so, a taxpayer must arrange for the replacement property to be held by a Qualified Intermediary (QI). As such, the QI must hold title or the deed on the property. Within five days of initiating this arrangement, the QI and the taxpayer must enter into an agreement which details that the QI is holding the property as a part of a 1031 exchange. As such, both the QI and the taxpayer must report the implications on their federal tax returns.
At this point, the same type of timeline requirements kick in. So, the taxpayer then has 45 days to indentify the property he will relinquish (it can be one or more potential properties). And within 180 days the transaction must close.
The advantages of the reverse stalker exchange are obvious. In addition to providing the property owner with the ability to defer the taxes associated with the sale of the property, it allows him to greatly reduce his risk by purchasing the replacement property first. So, this means that the property owner does not have to find a new and suitable property that he can identify within 45 days and close on within 180 days.
Finding Qualified Intermediaries
There are many companies that specialize in this complicated section of real estate and tax law. Some focus on specific geographic areas or regions and others operated nationwide. Many are subsidiaries of large title insurance companies. When looking for a QI, it is best to do some investigating. Some have suffered losses by working with QIs that eventually went bankrupt, whether by way of embezzlement or bad investment. This is not the rule with QIs, but it does point up some important questions to ask, such as how the QI intends to safeguard the funds held with them.
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