The Delayed, or “Starker” Exchange
The delayed exchange is the most common tax planning strategy available to real estate investors as well as the most common type of 1031 exchange perfomed. A delayed exchange means there is a time delay between the sale of the relinquished property and the purchase of the replacement property. A delayed exchange is also known as a “Starker Exchange” because of the federal case entitled, Starker v. U.S. 602 F2d 1341 (9th Cir 1979).
In a delayed exchange, the use of a Qualified Intermediary (QI) or Exchange Accommodator is required by law to facilitate the 1031 exchange. There are three steps to completing a successful 1031 exchange:
1) Sale of the Relinquished Property. Before closing on the sale of the relinquished property (the property you own and want to exchange) the Exchanger must retain the services of a QI. The QI prepares all of the 1031 exchange documents as well as escrow instructions to the escrow officer. The escrow officer is instructed to deliver the funds from the sale of the relinquished property directly to the QI, thus preventing the Exchanger from having actual or constructive receipt of the funds. The escrow officer is also instructed to “direct deed” the property from the Exchanger directly to the buyer. Once the funds have been received by the QI, access to the funds by the Exchanger is restricted for the remainder of the exchange. There are restrictions on the use and release of exchange proceeds under Section 1.1031(k)-1(g)(6) of the tax code. It is important to understand these restrictions before entering into a 1031 exchange of property.
2) Designation of the Replacement Property. From the day the Exchanger closes escrow on the relinquished property, they have 45-days to identify the property(ies) they intend to purchase. Identification of all replacement property must be made by the Exchanger in writing, signed and dated and must be delivered to the QI or an authorized recipient on or before the 45th day. No extension is allowed if this date falls on a Saturday, Sunday, or legal holiday. You may not identify replacement property after the 45th day.
There are three rules that apply when identifying replacement property. You must meet the requirements of at least one of these rules.
- 3-Property Rule: The taxpayer may identify as many as three properties, regardless of their total value; or
- 200% Rule: The taxpayer may identify any number of properties, provided their aggregate fair market value does not exceed 200% of the aggregate fair market value of all of taxpayer’s relinquished property; or
- 95% Rule: The taxpayer may identify any number of properties, provided they acquire replacement property with an aggregate fair market value equal to at least 95% of the aggregate fair market value of all the identified properties.
Your identification must be specific as to what you intend to purchase. For example, if you intend to purchase only a percentage interest in a piece of property, you must identify that interest. None of these properties can be for personal use and there are restrictions on acquiring property from related persons, if you plan to do so, please contact us first.
3) Purchase of Replacement Property. The Exchanger has the earlier of 180-days, or the due date to file their tax return, to complete the acquisition of the replacement property. Property acquired must be one or all of the identified replacement properties. The QI then purchases the replacement property with the exchange funds and causes the transfer of the replacement property to the Exchanger by way of a direct deed from the seller.
