Time Requirements And Mechanics Of A Tax Exchange

The Exchangor has a​ maximum of​ 180 days from the​ closing of​ the​ relinquished property or​ the​ due date of​ that year's tax return,​ whichever occurs first,​ to​ acquire the​ replacement property. This is​ called the​ Acquisition Period. the​ first 45 days of​ that period is​ called the​ Identification Period. During this 45 days,​ the​ Exchangor must identify the​ candidate or​ target property which will be used for replacement. the​ identification must:

- Be in​ writing,​
- Signed by the​ Exchangor,​ and,​
- Received by the​ facilitator or​ other qualified party (faxed,​ postmarked or​ otherwise identifiably transmitted through Federal Express or​ other dated courier service).

This must all occur within the​ 45-day period. Failure to​ accomplish this identification will cause the​ exchange to​ fail.


Three rules exist for the​ correct identification of​ replacement properties.

1) the​ Three Property Rule dictates that the​ Exchangor may identify three properties of​ any value,​ one or​ more of​ which must be acquired within the​ 180-Day Acquisition Period.

2) the​ Two Hundred Percent Rule dictates that if​ four or​ more properties are identified,​ the​ aggregate market value of​ all properties may not exceed 200% of​ the​ value of​ the​ relinquished property.

3) the​ Ninety-five Percent Exception dictates that in​ the​ event the​ other rules do not apply,​ if​ the​ replacement properties acquired represent at​ least 95% of​ the​ aggregate value of​ properties identified,​ the​ exchange will still qualify.

As a​ caveat it​ should be mentioned that these identification rules are absolutely critical to​ any exchange. No deviation is​ possible and the​ Internal Revenue Service will grant no extensions.

* Ironically,​ although only approximately 3-5% of​ exchanges are audited,​ the​ few exchanges which don't pass upon audit typically fail because of​ discrepancies in​ identification.

Mechanics of​ a​ Delayed Exchange

It is​ important that any exchange be carefully planned with the​ help of​ an​ experienced,​ competent and creative exchange professional. Preferably one who is​ completely familiar with the​ tax code in​ general,​ not just Section 1031,​ and who has extensive experience in​ doing many different kinds of​ exchanges. Thorough planning can help avoid many subtle exchanging pitfalls and also ensure that the​ Exchangor will accomplish the​ goals which the​ transaction is​ intended to​ facilitate.

Once the​ planning is​ complete,​ the​ exchange structure and timing are decided,​ and the​ relinquished property is​ sold and the​ transaction is​ closed,​ the​ facilitator becomes the​ repository for the​ proceeds of​ the​ sale. the​ money is​ kept in​ the​ facilitator's secured account until the​ replacement property is​ located and instructions are received to​ fund the​ replacement property purchase.

The funds are wired or​ sent to​ the​ closing entity in​ the​ most appropriate and expeditious manner,​ and the​ replacement property is​ purchased and deeded directly to​ the​ Exchangor. All the​ necessary documentation to​ clearly memorialize the​ transaction as​ an​ exchange is​ provided by the​ facilitator,​ such as​ exchange agreement,​ assignment agreement and appropriate closing instructions.

Partnership Exchanges and IRC §1.761-2(a) Elections

The Tax Reform Act of​ 1984 made it​ very clear that partnership interests cannot be exchanged and qualify for deferred gain treatment under IRC Section1031. the​ regulations also interpret no difference between general partnership interests or​ limited partnership interests. Although actual partnerships can exchange with other partnerships under Section1031,​ the​ exchange of​ an​ individual interest is​ prohibited.

However,​ the​ Omnibus Budget Reconciliation Act of​ 1990 did amend IRC Section1031 to​ incorporate the​ use of​ IRC Section1.761-2(a),​ Election of​ Partnerships to​ not be treated under Subchapter K of​ Chapter 1 of​ the​ Code,​ for the​ purposes of​ taxation. This means that Section1.761-2(a) can potentially provide an​ avenue to​ utilize Section1031 to​ those investors currently owning partnership interests.

So,​ how does an​ election under Section1.761-2(a) provide a​ benefit to​ the​ typical investor? Well,​ if​ every individual or​ entity within a​ partnership,​ elects to​ have his individual interest treated as​ his own real property interest,​ similar to​ a​ tenant in​ common interest,​ then that individual interest can qualify to​ be exchanged under Section1031. And since that partnership interest can qualify for deferred gain treatment,​ the​ amount realized from the​ sale of​ that interest can be used to​ acquire any qualifying replacement property.

Therefore,​ an​ interest from a​ partnership in​ which all partners have made individual elections under Section1.761-2(a) can be exchanged for any other property. And,​ there is​ no requirement that the​ investor exchange into replacement properties with his or​ her previous partners,​ only that the​ exchange be used for investment purposes only and not for the​ active conduct of​ a​ business.

Also,​ the​ converse of​ the​ above Section1.761-2(a) situation is​ possible. it​ is​ permissible for a​ partnership to​ acquire a​ property and elect to​ have the​ partnership interests treated as​ individual real property interests for taxation purposes,​ at​ the​ time of​ purchase. Therefore,​ as​ seen in​ some sophisticated transactions,​ particular partnerships which have already elected under Section1.761-2(a) may be established for the​ sole purpose to​ solicit investments from other partners exchanging out of​ one partnership (with the​ benefit of​ Section1.761-2(a)) into the​ new entity. This process enables the​ Exchangor to​ exchange out of​ one previously non-qualifying exchange investment into one which provides little or​ no management and superior cash flow or​ other benefits.

This strategy can also be used for business assets. in​ both cases,​ however,​ it​ is​ important to​ outline the​ goals and objectives of​ all parties involved in​ the​ exchange.

It should be noted that in​ every case involving an​ election under Section1.761-2(a),​ it​ is​ critical to​ evaluate the​ status of​ your election and exchange with the​ advice of​ a​ qualified tax professional. They will relate your situation to​ specific Internal Revenue Letter Rulings and other interpretations,​ which could assist in​ the​ strategic structuring of​ your transaction.
Time Requirements And Mechanics Of A Tax Exchange Time Requirements And Mechanics Of A Tax Exchange Reviewed by Henda Yesti on July 04, 2018 Rating: 5

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