There are eight steps common to any Section 1031 tax deferred exchange:
- Step 1: Retain the services of a certified public accountant or an attorney with tax deferred exchange experience
- Step 2: Enter into a 1031 exchange agreement with a qualified intermediary, being sure to name the qualified intermediary as the principal in the sale of the relinquished property and in the purchase of the replacement property
- Step 3: Sell the relinquished property, making sure to include a cooperation clause requiring the buyer to cooperate with the seller’s 1031 exchange, and instruct the escrow officer or closing agent to order exchange documents from the qualified intermediary
- Step 4: Escrow closes on the relinquished property, with the closing statement showing the qualified intermediary as the seller, and sales proceeds from the relinquished property are sent to the intermediary and placed in a separate segregated trust account
- Step 5: Within 45 days of the close of escrow of the relinquished property the taxpayer identifies one or more replacement properties and sends written notice of this to the qualified intermediary
- Step 6: The taxpayer executes a purchase contract with the seller of the replacement property, making sure the cooperation clause is included in the purchase contract, and naming the qualified intermediary as the buyer of the replacement property
- Step 7: Within 180 days of the close of escrow of the relinquished property, the taxpayer instructs the qualified intermediary to transfer funds to close and send 1031 exchange-related documents to the escrow company, and the sale closes with the closing statement showing the qualified intermediary as the buyer
- Step 8: The taxpayer reports the 1031 exchange to the IRS when filing his normal tax returns
After the replacement property has closed escrow the qualified intermediary will send a final accounting statement to the taxpayer. The statement will show that funds have come from one escrow directly into another, all without the taxpayer having constructive receipt of the funds.
Real estate investors should note that although the qualified intermediary is indicated as the seller and buyer on the purchase contracts, the deed and title are always from the taxpayer to the buyer, and from the seller to the taxpayer.