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Although the vast majority of exchanges occurring presently are delayed exchanges, let us briefly explain a few other exchanging alternatives.

Simultaneous Exchange
As mentioned previously, prior to Congress modifying the Internal Revenue Code as to exchanges and formally approving the concept of delayed exchanging, virtually all exchanges were of the simultaneous type. To qualify as a simultaneous exchange, both the relinquished property and the replacement property must close and record on the same day.

Some investors still try to accomplish simultaneous exchanges, primarily to avoid or reduce the payment of multiple closing fees or exchange fees to a facilitator. There is significant danger and legal exposure in this attempt since many unforeseen events can cause the closing to be delayed on one of the properties, leaving the investor with a failed exchange and the obligation of taxes that would otherwise be deferred.

For example, if the properties are located in different counties, it is highly unlikely that the closing can take place on the same day. If two different title, escrow, closing firms or attorneys are involved, it is virtually impossible for both to have the funds to close in their possession on the same day. For instance, with “Good Funds” laws existing in many states, an escrow holder cannot disburse funds not actually in his possession. Further, in directing an escrow holder to disburse funds for the purchase of the replacement property, it could be contended by the IRS that the investor had what is considered “constructive receipt” of the proceeds of the sale, and therefore taxes on the gain would be due.

However, the 1031 regulations contain what is referred to as a “Safe Harbor” provision, which does provide that in the event a facilitator or intermediary is used in a simultaneous exchange, and the transaction proves not to be simultaneous, the exchange will not fail simply for that reason.

Improvement and Construction Exchange
In some cases, the replacement property requires new construction or significant improvements to be completed in order to make it viable for the specific purpose the Exchangor has intended for the property. Such construction or improvements can be accomplished as part of the exchange process, with payments to contractors and other suppliers being made by the facilitator out of funds held in a trust account. Therefore, if the replacement property is of lesser value than the relinquished property at the time of the original transaction, the improvement or construction costs can bring the value of the replacement property up to an exchange level or value which would allow the transaction to remain tax free.

Business or Personal Property Exchange
Although our discussion in this tutorial involves the typical exchange of real property, Internal Revenue Code Section 1031 does allow the exchange of many types of property other than real estate. Investors may exchange, for example, rail cars, trucks, ships, classic cars or livestock, among other assets. Therefore, business exchanges are a common transaction.

While the basic exchange rules are the same, certain complications arise in classifying the non-real estate assets into one of several categories or SIC classes so that they meet the associated like-kind requirements.

While this is a simple enough process for the experienced facilitator, it can be thoroughly confusing for the uninitiated Exchangor, making the selection of his Intermediary or facilitator extremely important to the successful structuring of the exchange.

If you desire additional information regarding business or personal property exchanges, please consult an experienced tax professional to first determine the classes of properties available to be exchanged. Then, remembering that all personal property must be exchanged within the same class (locomotive for locomotive, collectible art for collectible art, pizza oven for pizza oven, etc.), assign values for the various assets within that class. These collective values, will then reflect the value of the total exchange.

Also, some personal property and business items are not exchangeable. Most notable in this group are such items as goodwill or inventory.

Again, as mentioned above, do not undertake the planning of a business or personal property exchange without the assistance of an experienced tax professional. In any business exchange, the time and money you invest in planning will be well worth it when your transaction is deemed qualified.

Reverse Exchange
The reverse exchange is actually a misnomer. It represents an exchange in which the Exchangor locates a replacement property and wants to acquire it before the actual closing of the relinquished or exchange property. Since the Exchangor cannot purchase the replacement and later exchange into property that he already owns, he must find a method to acquire the replacement property and still maintain the integrity of his exchange. Reverses are typically accomplished in two formats based upon transaction logistics and the financing needs of the Exchangor.

The Scenario A strategy is utilized only when the Exchangor requires traditional financing to complete his acquisition of the replacement property. Since few lenders would lend dollars to the Exchangor with the facilitator on title, it is necessary for the facilitator to warehouse or hold the title to the relinquished property. In this approach, the exchange is complete at the moment the Exchangor accepts the title to the new replacement property. However, with the prospect of the exchange being complete, it is necessary to balance equities between relinquished and replacement, prior to closing. In other words, upon closing the replacement, there must be an equal amount of equity in the replacement property as is expected to come out of the later sale of the relinquished property. Then, at the time of the later sale of the relinquished or exchange property, any debt is retired and the Exchangor is repaid any dollars which he advanced for the replacement property acquisition.

In Scenario A, the facilitator, with the aid of a loan from the Exchangor, acquires the replacement property and warehouses or holds the property title until such time as the relinquished property is sold and the exchange can be completed.

At this point we need to insert several caveats regarding reverse exchanges. They tend to be more complicated than other exchanges and because they involve the holding of title by a facilitator, they require extensive planning. Also, since the reverse exchange strategy was specifically excepted from the Treasury Regulations, they should be considered an aggressive form of exchanging. Do not undertake a reverse exchange without the assistance of an experienced and knowledgeable facilitator or Intermediary.

Delayed Exchange
Generally, when one discusses exchanges, the type of exchange referred to is the delayed or Starker exchange. This term comes from the name of the Exchangor who was first challenged for a delayed exchange by the IRS. From this tax court conflict came the code change in 1984 that formally recognized the delayed exchange for the first time. As mentioned earlier, this is now the most common type of exchange.

In a delayed exchange, the relinquished property is sold at Time 1, and after a delay, the replacement property is acquired at Time 2. The following will represent the traditional rules and time constraints for completing a qualifying delayed exchange.

Like-Kind Property
Property that qualifies for exchange under Section 1031 must be “like-kind”, which is defined in the Regulations as follows:

a) Property held for productive use in a trade or business, such as income property, or
b) Property held for investment.

Therefore, not only is rental or other income property qualified, so is unimproved property which has been held as an investment. That unimproved property can be exchanged for improved property of any type, or vice versa. Also, one property may be exchanged for several, or vice versa. This means that almost any property that is not a personal residence or second home is eligible for exchange under Section 1031. Even the vacation home that is used for that purpose part of the year, and is rented part of the year, is considered “mixed use” property and may be exchanged under 1031 for other mixed use property.

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