Delayed (aka Starker or Forward) 1031 Exchange Explained A-to-Z

**The information on this web page is provided for informational purposes only and should not be considered as legal, tax, financial or investment advice. Since each individual’s situation is unique, a qualified professional should be consulted before making financial decisions.**

In this guide we will discuss what a delayed 1031 exchange is and how it works, from the very first step to the end.

Deferring taxes allows you to keep more cash invested rather than lost to taxes. The goal is to conserve equity–those pre-tax dollars–allowing you to build an ever-larger portfolio.

Then, should you never sell outside this Exchange, your heirs can continue to defer taxes.

Let’s start with the definition of the term delayed 1031 exchange.

 

What Is a Delayed 1031 Exchange?

Here is a short definition of a delayed 1031 exchange:

A delayed 1031 exchange is a 1031 exchange in which the exchanger first sells relinquished property and then buys replacement property using the proceeds from the sold one.

There are a couple of synonyms for this transaction: starker exchange and forward 1031 exchange. A delayed 1031 exchange is the most common type among 1031 exchanges.

 

Taking Stock of Your Finances

You’ll want to review the particulars in your financial situation. Related expertise on your or an advisor’s part is needed. There’re lots of complexities to consider. For starters, are any of your holdings good candidates for an exchange?

Clearly these Exchanges can be a major benefit but first there’s groundwork to be done. Be mindful that they’re not the best answer in every situation. It makes sense to start with some general due diligence.

 

Step 1: Determine if a 1031 Exchange Is a Good Option for Your Situation

  • Eliminate unqualified properties such as primary residences, inventory, common stock, partnership interests, and indebtedness notes.
  • Determine whether you’re holding any good candidates for exchange. Perhaps you’re facing a big taxable gain on an appreciated property sale. A willing buyer with property that you want has been identified. Both properties (relinquished and replacement) are like-kind and held for business or investment purposes. Yes, exchanging an office building, e.g. for land qualifies as like-kind and may make sense.
  • Does selling multiple properties within one exchange make more sense? You would need to decide whether one multiple property exchange or several separate exchanges is best. Separate exchanges will give you greater flexibility with renewed timelines with each one. But it may not be practical buying replacements under separate purchase agreements.
  • Then too, a partial 1031 exchange while more complicated is feasible. You’re not required to exchange 100% of your property. Via the exchange documents you can designate amount(s) to be exchanged in percentage terms (learn more from our guide Can I Take Cash Out of My 1031 Exchange?).

Once you have a handle on what’s involved and where you stand, it’s time to make some serious calculations, monetary and otherwise. Bottomline does a potential exchange pass a cost/benefit litmus test? Weigh tax deferrals and any other benefits against 1031 Exchange costs and the many time-consuming requirements.

If you are exchanging out properties being sold as:

  • highly appreciated,
  • low income-producing,
  • located in undesirable areas,
  • too labor intensive,
  • an asset consolidation measure,
  • an investment diversification step, or
  • other validated net-benefit

then a 1031 exchange may well make perfect sense.

With one or more qualified relinquished property offerings, there’s at least one more consideration. Be mindful that sellers of replacement(s) must agree finally to sell. It’s one of the big 1031 Exchange risks to consider. If after 180-days of selling your property, seller(s) back out, the Exchange fails. This possibility leads some investors to opt for a Reverse Exchange instead.

A lot to take in, without a doubt. This is not a do-it-yourself endeavor unless you’re already a pro at it. Consulting a tax professional and one of the best 1031 exchange companies in your area may be in order.

 

Step 2: Choose One of Several 1031 Exchanges

Let’s say your review is encouraging. You’ll need a realistic strategy to ensure 1031 Exchange success. Well-conceived planning is invaluable, especially considering forthcoming, unforgiving exchange deadlines.

Four types of 1031 exchanges are in general use. The Forward Exchange is by far the one most commonly used option and will be covered here.

  • Forward (Starker) also known as Delayed Exchange. First you sell your relinquished property and then you acquire the replacement one. This exchange employs a qualified intermediary (QI) to act on your behalf. The QI uses proceeds from the sale of your relinquished property to buy like-kind replacement(s).
  • Reverse exchanges start with replacement(s) being acquired before the relinquished property is sold. In this buy first approach, you’ll need cash up-front.
  • Construction or improvement exchange permits investors to employ their equity to improve replacement(s) being held by an accommodator (Qualified Intermediary). Titles must be received and all equity spent on improvements within 180 days.
  • Simultaneous exchanges take place with replacement and relinquished properties exchanged on the same day. Both properties go to closing at the same time. No accommodator is required in the absence of boot.

Note: In a 1031 forward exchange, on selling your relinquished property you must buy like-kind replacement(s). Replacements are purchased with the profit from the sale of the relinquished property.

 

Step 3: Retain a Qualified Intermediary (Accommodator)

Retain and reach an Exchange Agreement with a Qualified Intermediary (QI), also called a 1031 exchange accommodator (aka facilitator). Ideally this should be done at least one week before closing on relinquished property. A QI is always required except in a simultaneous exchange involving no boot.

These accommodators are persons or companies that facilitate 1031 exchanges. They hold exchange funds for disbursal directly to replacement property sellers. They are neutral third parties having no other formal relationship with investors exchanging property.

Selecting a well-suited QI fitting your unique needs may be your most important decision. Their duties include acquiring the relinquished property from you for transfer to the buyer with title. Then, acquiring replacement(s) from sellers with deeds transferred to you at closing within 180 days.

 

Step 4: List/Negotiate/Sell Relinquished Property

Consider involving an experienced broker in selling your relinquished properties. These properties would be listed as usual, only notice is given that it involves a 1031 Exchange. To find one, use our list of the best commercial real estate agents and brokers near you.

Buyers are alerted that they’ll need to work within 1031 Exchange constraints. That entails little more than signing off on assignments and disclosures.

Your QI acts on your behalf as the property seller, holding sale proceeds in an escrowed Exchange Funds. Replacement(s) will be acquired later using these same proceeds.

Post-closing, an escrow account statement is provided by the QI laying out the 45 and 180 calendar-day 1031 exchange timeline for completing the exchange.

Warning: rather than the QI’s, any actual or constructive receipt by you of these sale proceeds would collapse the 1031 Exchange entirely. Receiving, pledging, or borrowing against these funds is prohibited by IRS 1.1031(k)-1(g)(6).

 

Step 5: Identify a Potential Property(ies)

Once the property closes, you have 45 days to identify potential replacements, generally three new properties. It may be advisable to start the replacement search in advance of the 45-day countdown. Failing to find replacement(s) – with sellers wanting your relinquished property – by that deadline results in a failed exchange.

To avoid taxable boot, the total value of acquired property(ies) must equal 95 percent or more of relinquished property value(s). The sale of one property for $1M, e.g. can be exchanged without boot with three properties totaling $950,000 or more in value. Learn more about boot taxation from our guide How Is Boot Taxed in a 1031 Exchange?.

Generally, offers are limited to three replacement properties. An exception is called the 200% Rule. That’s when all replacement(s) values combined are less than 200 percent of the relinquished property’s sales price. If relinquished property is sold for $1M, any number of replacement properties can be identified up to $2M.

Also, already identified property may be replaced with new replacements within that 45-days period. That is, initial choice(s) may be revoked and new properties identified.

If you want to learn more about property identification requirements, we have a guide on the 45 day period and other 1031 exchange property identification rules.

 

Step 6: 180-Day Replacement(s) Purchase Window

Including the 45 days to identify qualifying replacement properties, you have a total of 180 days to purchase replacement(s). You must be both the seller of relinquished property and buyer of the replacement(s).

Finally – through your QI – a sale agreement is reached with your replacement seller. Per the Exchange Agreement, your QI will use your relinquished property proceeds to purchase the replacement(s). Proceeds are transferred over to the title company or closing attorney.

Closing proceeds as in a routine transaction. You, any qualified agent [2] that you’ve retained, and your QI work together with the closing attorney or title company.

  • Replacement(s) are deeded over to you on payment.
  • You receive title to your new property.

Alert: within the shorter of 180 days or that tax year’s return filing deadline (with any extension), your title must be received. Missing this deadline rescinds any potential tax deferrals.

[2] Not qualified is any agent who’s been serving within the past two years as your regular agent, whether it’s a close relative, your attorney, broker, CPA, or real estate agent.

 

What Taxes Exactly Are Deferred

For example, you sell rental property purchased for $390,00 for $490,000. Having expensed $100,000 in depreciation, you now have an adjusted tax basis of $290,000. Your capital gain is $200,000 ($490,000 minus $290,000).

Without deferrals you are exposed to taxes at three levels.

  1. Regular capital gains tax rates apply to half ($100,000) of the gain per the following rate chart.
  2. If applicable, an additional 3.8% surtax is imposed on Net Investment Income when modified adjusted gross income (MAGI) exceeds above-specified thresholds. The intent is to tax high earners with significant investment income.
  3. The other $100,000 §1250 portion of the gain is depreciation being recaptured is to be excluded from favorable long-term capital gains tax rates. It’s taxed at ordinary income tax rates capped at 25%. Learn more from our guide 1031 Exchange and Depreciation Recapture Explained A-to-Z.

 

How to Ensure Your Exchange Is Legal and Safe?

Unless you are conducting a simultaneous exchange that doesn’t involve boot, you must use services of a qualified intermediary.

A professional, competent, and experienced 1031 exchange company with income tax experts on the team will advise you on the options you have to minimize your boot while getting the most of your relinquished property value.

They will ensure that the procedure is completed legally, in compliance with all IRS rules.

PropertyCashin is an all-in-one platform for commercial real estate investors that maintains relationships with top-rated 1031 exchange firms in all locations of the USA. To get connected with the best professionals and have your exchange processed safely and effectively, fill out the form below.

About the Author
Sam McGrath

As the Lead Commercial Real Estate Analyst at PropertyCashin, Sam McGrath is responsible for the company’s national sales strategy. Prior to his position with the company, Sam served as a Surface Warfare Officer in the United States Navy. Further, Sam was the National Recruitment Manager at Maxim where he expanded the Maxim healthcare brand nationally. He has over 8 years of experience in creative real estate investing. In addition, Sam has bought and sold commercial and residential property in over 42 states. Sam has a bachelor’s degree in business administration and marketing from Texas State University.

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