There are many types of conventional 1031 exchanges. There are also a lot of exchange-related transactions not specifically covered by Internal Revenue Code §1031. The variety and the terminology associated with the transactions can be confusing to taxpayers. Definitions of many of the terms that follow can be the rules. In fact, recognizing that persons may wish to apply these rules to simultaneous exchanges, the preamble to the exchange Regulations provide:
The rules in the proposed Regulations, including the safe harbors, apply only to deferred (delayed) exchanges. Commentators noted that the concerns relating to actual or constructive receipt and agency also exist in the case of simultaneous exchanges. They requested that the safe harbors be made available for simultaneous exchanges. Upon review, the Service has determined it necessary to make only the qualified intermediary safe harbor available for simultaneous exchanges. The final Regulations provide, therefore, that in the case of simultaneous transfers of like-kind properties involving a qualified intermediary, the qualified intermediary will not be considered the agent of the taxpayer for purposes of section 1031 (a). Thus, in such a case the transfer and receipt of property by the taxpayer will be treated as an exchange.
Three Party Simultaneous Exchanges
Most of the points related to a two-party simultaneous exchange apply to this type of exchange as well. The primary difference with this type of exchange is that only one of the parties wishes to do an exchange and the second party has no property to transfer to the taxpayer/exchanger. However, the parties arrange so a third-party seller of a target property is identified. The second party buyer acquires the target property from the third party and exchanges that property with the taxpayer to enable the taxpayer to compete their exchange. This type of transaction also closes simultaneously with all parties at the closing table.
Delayed or Deferred Exchange
These types of exchanges are by far most common. Here the taxpayer sells to the party of choice and has 45 days to identify in writing potential replacement property and 180 days (sometimes earlier based on the due date for tax return filing) to acquire one or more of the properties identified. This type of transaction is covered by the sold to the buyer through the intermediary and bought from the seller through the intermediary. Unlike the prior types of exchanges, the sale of the old property and the acquisition of the new property are not simultaneous.
In addition, the Regulations require that the during the period between the sale and the purchase, the proceeds of the sale, i.e. the exchange funds, be held outside the actual or “constructive” receipt of the taxpayer. This can be accomplished in a number of ways, however the most common and simplest is to have the qualified intermediary hold the funds for the benefit of the client. If replacement property is not identified or is identified but not all funds are used for acquisition, all or a portion of the exchange funds are returned to the taxpayer.
Reverse Exchanges
Under the exchange Regulations, exchanges have to be completed in the proper sequence. This means the sale of the relinquished property must take place prior to the acquisition of the new or replacement property. However, on occasion the facts are such that a taxpayer must acquire the new property prior to the sale or risk losing the desired new property. This reverse sequence is often referred to as a “reverse exchange.” Since exchanges have to be done in the proper sequence, embarking on this type of transaction is more complicated than a properly sequenced forward transaction.
In September 2000 the IRS issued a 180 days to find a true buyer of the old property and the buyer’s funds make everyone whole.
Build-to-Suit or Improvement Exchange
Build-to-Suit, also known as Construction-to-Suit or Improvement Exchanges pertain to situations where a taxpayer desires to use a portion of the proceeds from the sale of the relinquished property to build on vacant new property or to make improvements to new property being acquired. Since exchanges must be “like-kind” exchanges of real estate, once the taxpayer takes ownership of the new property, any value of improvements completed is considered payment for labor and materials which is not real property and therefore not considered like-kind. This problem can be overcome with a technique which is essentially a reverse exchange.
More specifically, the exchange company affiliate can take title to the replacement property on behalf of the taxpayer and cause the desired improvements to be made while under ownership of the exchange company affiliate. Upon the earlier of 180 days or the completion of the improvements the