This article debunks the myth that a formal exchange is a requisite in §1031 conveyancing and presents the general rule for direct deeding and the impounding of sales proceeds.
Preferable to sequential deeding
A property must have an equity over and above the loan encumbering it to be able to exchange it for other property. When an equity does exist in a property and allows an investor to demand something of value, a sale of the property will cash out the investor.
On entering into a sale of a property an investor’s wish to avoid a tax on the profit from the sale establishes the foundation for a §1031 exchange. However, taxpayer arrangements and Internal Revenue Service (IRS) obstructions in a §1031 exchange have long entertained the courts.
Until the 1990s, the IRS demonstrated an aversion to an investor’s conversion of a cash-out sale into a §1031 exchange. The IRS often disqualified a §1031 profit tax exemption when a cash-out sale of property was first entered into by an investor. That the investor entered into a separate agreement to purchase a replacement property and that, on closing the two transactions, the investor received nothing but the replacement property, made no difference in analysis to the IRS. It was the means used by the investor, not the end result of the reinvestment, that caused problems with the IRS.
The IRS stance was asserted repeatedly over decades in spite of a continuous flow of consistent judicial decisions to the contrary. The courts define a §1031 exchange as a sale of one property and the purchase of another by reinvestment, with the condition that the investor does not receive any cash from the sale prior to becoming the owner of a replacement property.
The position adhered to by the IRS was that an economic exchange must occur between two persons, each holding true ownership in the property sought by the other. The IRS felt no exchange could possibly occur if a buyer who acquired an investor’s property only had cash to do so. The buyer acquiring the investor’s property then would not be the true owner of the replacement property the investor eventually acquired with cash from the buyer.
Thus, to satisfy the IRS in the past, the buyer of the investor’s property would had to have been burdened with all the benefits and obligations of ownership to the replacement property sought by the investor, in order for a direct exchange of property to occur. Ownership of a property entails possession, collection of rents, the obligation of operating expenses, loan payments, etc.
Passing title momentarily through the buyer, however, would not be acceptable to the IRS either. Transitory title carries with it no ownership. True ownership would still be with the seller of the replacement property who, for cash, passes it from himself to the investor who actually acquires the property. At no point in this transfer would the buyer ever hold true ownership. Thus, the IRS would have claimed the investor was merely using the cash from a sale as an artifice to acquire a replacement property by exchange. The IRS contended that a situation of this kind must be treated as a receipt of cash, which would disqualify most reinvestments in real estate.
The irony of the IRS persistence for the existence of a pure two-party exchange to qualify the investor’s profit for a §1031 exemption was the accompanying rise within the real estate industry of support for the deed-for-a-deed barter approach. Escrows and those who hold themselves out as intermediaries were the most supportive. Further, all were accomplices in the exploitation of investors under the present IRS safe harbor rules as an alternative to the general rules for avoidance of receipt and the customary use of direct deeding between sellers and buyers of properties.
Yet, since 1980, the IRS has been remarkably lenient in its audits of §1031 exemptions taken by investors, as long as some effort was made to keep the cash sales proceeds out of the investor’s personal bank account. IRS looked for, according to their audit manual in the early 1980s, a formal trust arrangement used to hold the funds during any delay between closing a sale and reinvestment.
The “exchange” without an exchange
“I’ll trade this, which I own, for that, which you own.” On an acceptance of this offer, a bargain by barter is created, an exchange in the plain meaning of the word “exchange”. That said, rarely does an exchange of this kind exist today in real estate transactions, thanks primarily to the general stability of currencies and the ease of the transfer of monies as a medium of exchange.
The economic substance underlying the “this for that” exchange is that the true ownership in the property is actually held by each person who transfers to the other the beneficial rights to possess, sell, encumber or rent the property to be acquired in the exchange. Thus, an actual exchange is ownership for ownership.
Conversely, the person, such as an intermediary, who receives and momentarily holds a conveyance of naked title, namely transitory title (which does not include the transfer of any ownership rights in the property to possess, rent, encumber or sell in), receives nothing of legal consequence or economic substance. The legal function of the conveyance of mere transitory title of a property to someone is the creation of a resulting trust on that title. Title is held in trust for the true owner to possess, rent, encumber or sell the property. [In re Sale Guaranty Corporation (9th Cir. BAP 1998) 220 BR 660; DeCleen v. Commissioner (2000) 115 TC 457]
While an exchange in the world of economic arrangements is a two-party barter agreement, the tax purpose of a §1031 exemption requires the IRS to apply the exemption in light of the commercial realities of a sale and reinvestment in order to accomplish the congressional goal of transferring an equity in one property to an equity in another.
By necessity, cash is the primary, if not exclusive, incentive for buyers and sellers of property. Thus, the conduct of an investor in a §1031 exchange is in reality quite different from the two-party bartered exchange, although the end results for all involved are the same.
Consider, as we must, that a §1031 exchange represents a continuous commitment to an investment in the ownership of real estate. The component parts of the continuous investment include the:
sale of one property by an investor; and
purchase of replacement property by the investor.
A break of 180 days in the continuity of the investment is permitted. During this reinvestment period, all or a portion of the sales proceeds must be held by a third party on behalf of the buyer. The funds are unavailable to the investor but available to be used by the investor solely for the purpose of reinvestment.
Any method or arrangement, no matter how simple or complex it may be, can be used to accomplish the objective of a sale of one property and the purchase of another in a §1031 reinvestment plan.
Thus, in a §1031 sale and reinvestment, only four parties need to be involved, albeit in entirely separate transactions on different properties, including:
the investor with a property to be sold and a purchase to be made;
the buyer of the investor’s property;
the seller of the replacement property the investor is acquiring; and
the depository used to facilitate the transfer of funds between transactions and to avoid their receipt by the investor.
Arguably, as contended by the IRS until 1990, no exchange occurs under any plain meaning of the word “exchange” when a cash-out sale of one property is first negotiated and the funds from the sale are used to purchase other property, no matter how this is accomplished. However, this is precisely the economic substance of today’s §1031 exchange, with the crucial addition of the depository necessary for the investor to avoid legal receipt of the sales proceeds he will reinvest.
The uncertain days of the pre-1980s are gone. Then, the common belief among brokers was that an exchange had to look like an exchange and act like an exchange, or it was not an exchange.
However, the actual exchange of properties in a §1031 exchange today, comprised of a sale of one property, impounded funds and the purchase of other property, is far from an “exchange”.
Economics of the §1031 exemption
In the worlds of business and real estate operations, §1031 serves a singular purpose. The profit tax exemption is intended for those who use or operate real estate, such as businesses and landlords.
Should the businessman or landlord need to shift from one property to another to continue his line of business, be it a trade, a rental operation or ownership of unused land, the §1031 exemption allows him to do so without diminishing his working capital by regressive tax schemes.
If Internal Revenue Code (IRC) §1031 did not exist, the real estate owner confronted with the need to relocate his assets would be taxed. His wealth and ability to maintain the level of commercial or rental activity he engaged in before the exchange would be diminished. Thus, the general economy would suffer from a loss of assets from taxation, or, if no move was made because it would be taxed, the loss to the economy of more efficient and effective operating facilities or rental operations (residential or nonresidential). The result would be a failure of the economy to grow – a result of regressive taxation.
Also consider that §1031 applies to personal property, whether it is owned by a business operator, a rental landlord or a collector of personal property. Landlords and businessmen require a lot of equipment to operate. On trading equipment in when fully depreciated to acquire replacement fixtures, furniture, vehicles or furnishings to upgrade his operations, an owner will be taxed on the value of the items he traded in. Without §1031, he would have no relief from a diminished ability to operate due to the reduction in assets by the payment of taxes.
The intent of §1031 is to allow assets used in the business or real estate investment activities to be exchanged for replacement property without taxation so the owner can continue with his business or real estate investments unhindered by taxation.
For example, a farmer may need to relocate his operations to other, more suitable land due to encroaching residential or nonresidential development or zoning. Or he may need better quality land for higher production, a larger parcel for efficiency in the size of his operation, a shift in the location of crops to meet market demands, access to less expensive or greater quantities of water or just better weather conditions – all for the purpose of continuing his occupation.
Also, landlords are motivated to shift their current rental property, residential or nonresidential, due to numerous marketplace and personal reasons that are all related to the continuing use of real estate. The size or quality of improvements may need to be more manageable, or another geographic location is needed or desired by the landlord. Other reasons an investor shifts from one property to another could be socio-economic conditions in or about a rental property, land use changes rendering the property obsolescent as managed, or simply to build an equity by moving on up into a larger project to own and operate. These all qualify as §1031 exchanges.
In contrast, investors in the stock market do not have a profit exemption equivalent to the §1031 exchange. Congress deliberately intended they not get relief when selling shares and reinvesting in other shares. Stockholders, except venture capitalists and buyers of original issues, add nothing to the goods and services produced in this country. They buy and sell existing positions that are economically static.
Stockholders do not use the assets they own to provide goods and services, they do not participate in management of the business or real estate investment trusts (REITs) that originally issued the stock, nor do they operate the property involved. Stockholders buy and are inactive as they wait with the expectation that someone else will buy their position, hopefully at a higher price.
It’s the end result, not the means
The courtroom odyssey that eventually structured the streamlined §1031 reinvestment plans of today began in 1935 with the application of the principle of “substance over form” as the basis for applying the purposes of the tax code sections. The rule has since then been applied to determine whether a sale and reinvestment put together in a related series of contracts and conveyances was, in substance, a §1031 exchange.
For starters, to have an ulterior tax motive when entering into a transaction is a legal right held by taxpayers. If an investor can structure a transaction to avoid or at least decrease the amount of taxes he would pay on a sale of property and does so by any means permitted by law, he is entitled to do so. Thus, a series of transactions used by an investor in an attempt to qualify for a §1031 exemption is reviewed to determine whether the investor actually accomplished the activity intended by Congress to qualify for the §1031 exemption.
Setting aside the tax motives behind §1031 transactions, it is the actual end result of a series of transactions that sets the character of the reinvestment effort. Taxes are imposed based on the economic substance of the taxpayer’s transactions, not whether an exchange between two parties actually occurred. [Gregory v. Helvering (1935) 293 US 465]
Further, the tax consequences of a sale of property are not determined by a review of the means employed by the investor to transfer legal title (except on a failure of the buyer to cooperate). Rather, the sale of one property and the purchase of another in a §1031 reinvestment plan are viewed as a whole. Each step prior to the completion of the related transactions, from the beginning of negotiations to the closing on the transfer of the replacement property, is relevant, sometimes called the completed transaction theory. [Commissioner v. Court Holding Co. (1945) 324 US 331]
In the midst of these judicial decisions on the substance of §1031 exchanges, the foundation was set for the judicial opinions that eventually simplified the character of a §1031 exchange as the sale and reinvestment we know today.
In the 1940s, consider a broker acting as a principal, who enters into an agreement with an investor to buy a property the investor no longer wants. In exchange for the property, the broker is to obtain a specifically identified replacement property the investor wishes to purchase.
First, the broker locates a cash buyer for the investor’s property. The broker enters into a purchase agreement to sell the investor’s property to the buyer for cash. The broker then negotiates with the seller of the specific replacement property to buy it for cash. They enter into a purchase agreement. Separate escrows are opened for each of the cash transactions in the name of the broker as the seller in one and as the buyer in the other.
No escrow is opened to handle the broker’s agreement with the investor to acquire the investor’s property in exchange for the replacement property.
The investor executes a deed to his property, conveying it directly to the cash buyer. The deed is placed in the sales escrow opened in the name of the broker as the seller of the investor’s property. Escrow is instructed to record the investor’s deed to the buyer once a deed to the replacement property can be recorded and insured in the investor’s name.
The seller of the replacement property executes a deed conveying his property directly to the investor. The deed is placed in the purchase escrow opened by the broker as the buyer of the replacement property for cash.
At no time is the broker, or anyone else other than the investor, the common titleholder of both the properties, much less the true owner of both properties. Clearly, no exchange of titles occurs, nor, more importantly, does an exchange of ownership take place between just two parties.
The deeds conveyed title from the titleholders who owned the properties directly to the true buyers of each property. No sequential deeding occurred to mask the cash sales by placing either:
the buyer of the investor’s property in the chain of title to the replacement property;
the seller of the replacement property in the chain of title to the investor’s property; or
anyone else as a strawman in the chain of titles, called an intermediary.
Further, possession and rights of ownership were transferred directly from the investor to the cash buyer, and from the cashed-out seller of the replacement property to the investor. Does the exchange qualify for the §1031 exemption?
Yes! The broker, as the facilitator, bound himself to deliver properties he did not own and would never own. He merely contractually sandwiched himself between the sale of the investor’s property and purchase of the replacement property, but not in the conveyancing. However, the result is still the same: the investor’s reinvestment plan shifted his equity in one property into another property and qualified his profit for the §1031 exemption. [W. D. Haden Co. v. Commissioner (5th Cir. 1948) 165 F2d 588]
Thirty years later, an IRS ruling conceded one point in Haden. The buyer’s cash, originally destined to pay for the investor’s property, could, by amended escrow instructions, be used to purchase the replacement property and qualify for a §1031 exemption. Implicitly, the IRS, by their ruling, conceded that ownership of the replacement property does not need to be held first by the investor’s cash buyer or any other third party.
Thus, another unnecessary step in the sale and reinvestment activities that qualify for the §1031 profit exemption was, by IRS ruling, eliminated by regulations to conform with Haden. However, no mention of the direct deeding permitted by Haden case was included in the ruling. [Revenue Ruling 77-297; Alderson v. Commissioner (9th Cir. 1963) 317 F2d 790]
In the 1990s, nearly 40 years on from Haden, an IRS ruling finally conceded that title to the replacement property need not pass through the name of the buyer before the transaction may qualify as a §1031 exchange. The judicial decisions in all prior cases involving §1031 exchanges established the congressional intent that “the end result, not the means” eliminated any need for sequential deeding. [Rev. Rul. 90-34; Biggs v. Commissioner (5th Cir. 1980) 632 F2d 1171]
The artifice of concurrent closings
During the lapse of years between Haden and IRS acquiescence in revenue rulings and regulations, another unnecessary step previously insisted upon by the IRS was also eliminated in the process of selling one property and buying another in a §1031 exchange. It was a modification of the cash-out sales agreement.
Prior to the 1980s, the IRS had always insisted that amending escrow instructions to re-rout and divert the cash proceeds from the sale of an investor’s property to buy replacement property in order for the investor to avoid actual receipt, was an artifice dressed up like an exchange. The modification of purchase agreements by amended escrow instructions made a sale and reinvestment look like an actual exchange and merely covered for what had actually occurred – a cash-out sale avoided only by redirecting the cash to the purchase of a replacement property. The IRS claimed this type of transaction did not qualify for the §1031 exemption.
Again, the courts had a simple answer: It was the end result that mattered, not the means by which the investor used escrow or other contracting devices to get the replacement property. As long as the investor did not actually or constructively receive all the sales proceeds before the replacement property was purchased, the transaction could qualify for the §1031 exemption. [Barker v. Commissioner (1980) 74 TC 555; Alderson and Biggs, supra ]
After the IRS no longer required an exchange of ownership for ownership and there was no need to locate a cash buyer who would agree to use his cash to purchase the replacement property to concurrently exchange titles in sequential deeding, it was just a matter of time before the courts approved a delayed delivery of the replacement property to close out a §1031 reinvestment plan after closing the sale of property to a cash buyer. Judicial confirmation of the delayed closing of the reinvestment occurred in the 1970s, effectively ending the need for formal exchanges within the brokerage community and sequential deeding by escrows. [Starker v. United States (9th Cir. 1979) 602 F2d 1341]
In the 1980s, the IRS withdrew its opposition to cash-out sales and reinvestments, unless escrow closing statements confirmed the investor actually received the cash. However, the IRS did generate deferred exchange regulations that substantially complied with court decisions. In 1984, Congress embraced the cash sale and delayed reinvestment by enacting the 45-day and 180-day property identification and reinvestment codes.
The chaos of deeding remembered
Contractually convoluted movements of money and titles through multiple parties to sequentially pass the final deed to the investor is the subject of many §1031 court cases. In each case, the investor ultimately received replacement property, not the cash from his sale. In the judges’ opinions, however, they disapproved of these convoluted approaches.
All of the delayed reinvestment transactions cases could have been handled in just three contracts:
A purchase agreement and escrow instructions for the sale of the investor’s property, entered into by the investor and his buyer.
A purchase agreement and escrow instructions for the investor’s purchase of the replacement property entered into by the investor and the seller of the replacement property.
An agreement between the buyer and a facilitator to, as the third party depository, receive and hold the cash from the sale, and then later disburse it for the investor’s purchase of replacement property.
The use of unnecessary parties and sequential steps drove one judge to observe that the reinvestment plan being disputed, although it ultimately achieved the intended result, could have been accomplished with a fewer steps. [Biggs, supra]
In another case even more convoluted than Biggs, a creative escrow officer nearly lost track of the intended purpose of delivering the replacement property to the investor. The sequential deeding of all the properties involved through a strawman in a parade of title was seen by the court as unnecessary in determining the true character of the transaction for §1031 tax purposes.
The IRS had contended in this case that all the amendments, surplus documentation and transitory transfers of titles comprised an artifice, used by the investor to give the transaction the appearance of a true exchange, which it, in fact, was not. The IRS claimed the investor’s actions placed him in receipt of the cash and constituted a taxable sale, not an exchange. In the end, however, the investor only received the replacement property, not the cash, thus qualifying the transaction for the §1031 exemption. [Barker, supra]
The distinction between a closed sale, which delivers cash to the investor, and a §1031 exchange, which delivers the replacement property to the investor, is uniquely straight forward: A sale is evidenced by the receipt of cash for the property, but receipt of property for property does not constitute a sale.
Where the cash proceeds end up at the close of a sales escrow determines the tax results of a transaction. An investor who deposits the cash proceeds from a sale into a purchase escrow two days after his receipt of the proceeds, then closes it the following day does not avoid triggering taxation, even though the investor used all of his net proceeds to buy the replacement property.
The cash on close of escrow was freed of all restriction, and there were no contractual restraints on the investor to bar his use of the sales proceeds as he saw fit. The proceeds had to be taxed, and although the decision was harsh, the court was sympathetic but unyielding. The investor achieved exactly what Congress intended by shifting his equities to continue his trade or business on a bigger and grander scale than before, but he did not do so according to IRS rules and thus was taxed. [Carlton v. United States (5th Cir. 1967) 385 F2d 238]
A deed one step too soon
An investor can delay acquiring ownership to replacement property. However, he cannot reverse the process and delay the sale of his property without someone else temporarily taking title and ownership to it. An investor who acquires ownership of the replacement property in his name before he closes escrow on the property he is selling is not permitted in a §1031 reinvestment plan, because it is concurrent ownership.
The overlap of ownerships occurs when the investor advances funds to purchase the replacement property, and then takes title to it in his name prior to closing the sale of his property. This situation arises when an investor is faced with losing the opportunity to acquire the replacement property and must prematurely close his purchase escrow.
Two procedures exist to avoid concurrent ownership. One, under the general rules, is an interim ownership held by an unrelated person. In this procedure, escrow instructions are modified by substituting the interim owner as the buyer of the replacement property in place of the investor, a transfer of rights called an assignment. The funds necessary for the interim owner to purchase the replacement property are borrowed from the investor.
Concurrently, the interim owner enters into a purchase agreement to resell the replacement property to the investor. The interim owner will deliver ownership to the replacement property when the investor closes escrow on the sale of his property, however long it may take. Here, the interim owner, for a period of unknown duration, is sandwiched into ownership of the replacement property.
The other procedure to avoid concurrent ownership is a safe harbor process that vests mere title in an interim titleholder while placing the functional ownership of the replacement property into the hands of the investor. Each step in the process is controlled by IRS regulations and a 180-day period during which the investor’s property must be sold or the opportunity to apply a future §1031 on the purchase of the replacement property is lost.
The unwilling buyer alternative
The artifice of an exchange, while frowned on by the IRS in past §1031 cases, is a scheme now adopted by the IRS in their safe harbor regulations as an alternative to the general rules for avoiding the receipt of sales proceeds. The safe harbor regulations provide for sequential deeding of titles to all properties and the transfer of cash through a central intermediary to avoid receipt of the proceeds from a cash sale. An investor can elect to use the safe harbor intermediary to avoid receipt of his sales proceeds when he is confronted with a buyer who is unwilling to cooperate in the establishment of a buyer’s trustee to hold the sales proceeds under the general rules for avoidance.
The election to go with the safe harbor sequential deeding regulations is necessary when the buyer either:
refuses to agree to the boilerplate, preprinted §1031 cooperation clause that is now standard copy in purchase agreement forms; or
had agreed to cooperate and is now breaching the cooperation provision (and thus the purchase agreement).
Either way, the investor’s only alternative, besides withdrawing from the purchase agreement with this buyer or worse, canceling the existing purchase agreement, is to resort to the safe harbor sequential deeding rules.
The IRS openly acknowledges an investor’s use of the general rules for avoiding receipt of cash proceeds by calling for buyer cooperation in the establishment of a third-party depository. Each IRS example of an investor’s election and use of the safe harbor intermediary is prefaced with the condition that the buyer is unwilling to participate in a §1031 reinvestment plan under the general rules for avoidance of receipt. [Revenue Regulations §§1.1031(k)-1(g)(8), Examples 3, 4 and 5, 1.1031(k)-1(j), Examples 2, 3 and 4]
A broker who negotiates the sale of property on behalf of an investor, believing the investor might reinvest the sales proceeds in replacement property, will include a §1031 cooperation clause in the buyer’s offer to purchase. If the clause is not in the offer submitted by the buyer, the provision will be included in the counteroffer.
When the buyer cooperates, the investor reduces his risk of loss to just that carried by a buyer’s trustee, selected from among the investor’s friends and business acquaintances. Further, he reduces his costs of escrowing and managing the funds until needed for the purchase of his replacement property.
An intermediary holding the cash exposes the investor to an unnecessary risk of loss, comparable to the risk of delivering the funds by a motorbike or by the use of a tank, when electing, respectively, between the use of the safe harbor “non-trustee” intermediary procedures or the buyer’s trustee under the general rules for avoiding receipt.
The §1031 exchange in future
The constant redefining and restructuring of §1031 reinvestments over the past 60 years, have reduced the events necessary to comprise a §1031 exchange to include just three steps:
the sale of property;
the avoidance of receipt of money; and
the purchase of replacement property.
It is the avoidance of receipt step, concerning the handling of §1031 money, that remains as the last, unnecessary step. With time and more information, the requirement for avoidance of receipt will be seen as more than what Congress intended, especially when viewed against the backdrop of the 180-day period requirement for using the cash to complete the §1031 transaction.
IRC §1031 does not address actual or constructive receipt of sales proceeds during the 180-day reinvestment period. The code neither permits nor disallows a §1031 exemption if the investor were to get all of the sales proceeds, then personally deliver up the funds for the reinvestment within the 180-day delay period.
A decision by the IRS to lessen §1031 requirements by eliminating the actual or constructive receipt rule would reduce the chaos now faced by an investor or businessman who wants to acquire an economically more efficient property. The §1031 exchange in the future could do away with the following unnecessary steps:
The nonfunctional third-party position holding funds that could as easily be held by the investor to achieve the same tax accounting result.
The harsh, judicial results of an actual receipt of the cash sales proceeds and their reinvestment since the IRS objects to the end result due to the means used to obtain it.
The safe harbor rules of sequential deeding.
Prior planning for §1031 events
Prior to taking a listing on any property other than a seller’s principal residence, the broker or agent soliciting the employment should know precisely what additional documentation and activities the seller will be confronted with, just in case the seller decides to buy replacement property to avoid profit taxes on the sale.
The following is a list identifying each party connected in some way to a §1031 reinvestment plan. For each party, an itemized list is included of the events they will be involved in.
The use of this information for §1031-related documentation and activities can only be applied to transactions in which the buyer promises to cooperate in the accommodation of the seller’s §1031 reinvestment plan by the inclusion of the §1031 cooperation provision in a purchase agreement. If the buyer does not agree, or agrees and later refuses to cooperate in the documentation, then the only alternative for the seller is the safe harbor election to avoid receipt by the use of an intermediary.
Here, the list only includes the activities needed to comply with the general rules for avoiding receipt.
| 1. | The listing agent and his broker: | |
| a. | Conduct a tax analysis with the investor reviewing the benefits of a §1031 reinvestment plan. | |
| b. | Know and discuss with the investor the documentation and activities imposed on each party involved in the sale and reinvestment. | |
| c. | Maintain the investor’s control over the sales proceeds, including personal knowledge about the person who receives the proceeds, how they are to be held and the risks of using a buyer’s trustee selected by the investor as opposed to a safe harbor intermediary. | |
| 2. | The buyer of the listed property: | |
| a. | Include a §1031 cooperation clause in the purchase agreement by preprinted form or addendum. | |
| b. | Enter into a Declaration of Trust agreement to establish a trust to hold the investor’s sales proceeds, in order to complete the buyer’s performance of his agreement to cooperate. | |
| c. | Enter into closing instructions, authorizing escrow to deliver the investor’s net sales proceeds to the trustee, and not the investor, on closing. | |
| 3. | The investor selling his property: | |
| a. | Include a §1031 cooperation clause in the purchase agreement or the investor’s counteroffer to reduce paperwork and the risk of loss by use of a trustee. | |
| b. | Select a person (other than a relative or controlled entity) to act as trustee (and an alternate as a successor) to hold the net sales proceeds, someone known to the investor as reliable and trustworthy. | |
| c. | Confirm the buyer enters into a Declaration of Trust agreement appointing and authorizing the trustee to use the net sales proceeds on the seller’s instructions and solely for the purpose of purchasing replacement property. | |
| d. | Enter into amended escrow instructions redirecting the net sales proceeds to the trustee selected by the investor. | |
| e. | Deed the property directly to the cash buyer. | |
| f. | Instruct the trustee to fund the purchase for the replacement property on a call for funds from escrow. | |
| 4. | The §1031 trustee: | |
| a. | Enter into the Declaration of Trust agreement with the buyer. | |
| b. | Receive delivery of the net sales proceeds on the close of the sales escrow and deposit them in an insured savings account in the name of the trustee. | |
| c. | Withdraw the funds, payable to escrow or by a wire, for the purchase of the replacement property on instructions from the investor and a call from escrow for the funds. | |
| 5. | The seller of the replacement property: | |
| a. | No involvement in the §1031 reinvestment plan, other than closing escrow and deeding the replacement property directly to the investor. | |
| 6. | Escrow for the sale of the listed property: | |
| a. | Use standard sales escrow instructions. | |
| b. | Prepare amended closing instructions calling for escrow to disburse the cash net sales proceeds to the trustee named in the instructions, not to the investor. | |
| c. | Convey the property by deed directly from the investor to the buyer. | |
| d. | Disburse the net sales proceeds to the trustee, not the investor. | |
| e. | Prepare the closing statement (settlement sheet) to state the investor’s receipt of consideration for the sale is Exchange Valuation Credits (EVCs) in an amount equal to the cash proceeds (and any carryback note) disbursed to the trustee. | |
| 7. | Escrow for the purchase of the replacement property: | |
| a. | Use standard purchase escrow instructions. | |
| b. | Call for the closing funds from the §1031 trustee, and, on a third-party receipt by escrow, credit the funds to the account of the investor in escrow. | |
| c. | Convey the replacement property by deed directly from the seller to the investor. | |
