Overview Of A Forward Exchange.
The Internal Revenue Code Section 1031 encourages reinvestment in qualifying business and investment assets by enabling companies and individuals (Exchangers) to reallocate their capital into new assets more suitable to the Exchangers’ current business or investment objectives, without the imposition of income taxes.
Under Section 1031, a Forward Exchange allows Exchangers to achieve substantial tax deferral on gains from the sale of property, when they also acquire like-kind property. A Forward Exchange may also defer the tax on depreciation “recapture,” which is taxed as ordinary income, rather than capital gains.
Section 1031 offers a “safe harbor” to Exchangers that use a Qualified Intermediary (QI), such as NES. A QI is an independent third-party that serves as the Exchanger’s exchange counterparty and holds the Exchanger’s funds during the period between the sale of the relinquished property and the purchase of the replacement property, so that the Exchanger does not receive those funds and trigger tax gains from the sale of the relinquished property.
Forward Exchange Rules.
Preparing for the exchange:
- The relinquished and replacement properties must be held for investment purposes or for productive use in trade or business. Therefore, exchange treatment is not available to dealers buying or selling inventory.
- Each replacement property must be “like-kind” to the relinquished property.
- Real estate is generally considered like-kind to any other real estate.
- For tangible depreciable property other than real estate, the regulations provide a safe harbor that allows those properties to be matched using a classification system based upon the NAICS codes or general asset classes.
- To fully defer the capital gains and depreciation recapture taxes, the Exchanger must:
- Acquire replacement property of equal or greater value to the relinquished property.
- Use all the cash proceeds from the sale of the relinquished property for the purchase of the replacement property.
- Place debt on the replacement property that equals or exceeds the debt on the relinquished property.
The exchange:
- Legal documents such as an Exchange Agreement and certain assignments and notices with respect to the relinquished sale agreement are required and must be executed prior to the sale of the relinquished property.
- The Exchanger, within 45 calendar days after the transfer of the relinquished property, must clearly and unambiguously identify the potential replacement properties.
- The Exchanger may identify up to three properties without regard for their fair market value.
- The Exchanger may identify more than three properties so long as their combined fair market value does not exceed 200% of the fair market value of the relinquished property.
- If the Exchanger exceeds the 200% limitation or three- property rule, it must acquire at least 95% of the fair market value of the properties identified.
- The Exchanger may not receive cash proceeds from the sale of their property. In order to prevent receipt, funds are held by the QI in an exchange account throughout the exchange period.
- Within 180 calendar days after the date of the transfer of the relinquished property, the Exchanger must acquire one or more of the identified replacement properties.
NES Services
NES offers an unsurpassed level of expertise and experience in conducting smooth, secure and successful Forward Exchanges and works closely with clients and their advisors through every stage of the exchange. NES’ comprehensive services include:
- Opening a new exchange account and working closely with clients and their advisors through every stage of the exchange.
- Establishing a Qualified Escrow or Qualified Trust account to hold and protect the proceeds from the sale of the relinquished property.
- Assisting with timely notifications of deadlines.
- Persistent digital archive of executed exchange documentation.
Click on the link below for more in-depth information about NES' Forward Exchange solution:
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