Section 1031 made its way into tax legislation in 1921, almost a hundred years ago. At the time, until the mid-1980s, it was thought that selling and buying had to take place „simultaneously,” isn`t that the reasonable definition of a business between two people? Apparently not. From the late 1970s to the mid-1980s, in the landmark case of Starker v. United States, a federal district court in California found that there appeared to be no requirement for simultaneity in the plain language of Section 1031. This seemingly innocuous decision opened a Pandora`s box of possibilities, not to mention confusion. The time limit for entering into the transaction with its buyer in the Starker case was five years. In 1986, shortly after the decision was announced, Congress opted for a legislative solution. It agreed that Article 1031 did not require that the exchange of goods take place at the same time, but decided to limit the indefinite duration in order to complete the negotiation of one for the other to 180 days. Essentially, this limited period of time still allowed the two transactions to be close enough in time to be considered interconnected.
But anything that comes from a longer period of time has simply broken the link between sale and purchase in unrelated transactions (for tax purposes). Under IRS regulations, parties must be notified that an assignment has taken place. Therefore, the required Assignment Notice 1031 must be processed prior to settlement. But practical problems abound. One of the biggest problems was knowing what to do with the buyer`s funds during the transition period between sale and purchase. Section 1031 still required an effective exchange between the taxpayer and the buyer. If the seller took the money and used it within 180 days, it wasn`t enough. By the time the taxpayer received the funds, the business became a taxable sale, regardless of whether new properties were acquired on time or not. It was not comparable to the old rules where you could postpone the sale of a personal apartment if you bought a new one within two years. One solution was to allow the buyer to keep the funds with the contractual obligation to use them to buy the new property as soon as the seller was ready to do so. There are so many obvious risks involved in this that there is no need to explain it. The only way for the seller to compel the buyer to sign the required agreement was to provide for that buyer`s obligation in the body of the purchase/sale contract.
Therefore, for this purpose, a clause appeared in the contracts that obliged the buyer to perform the Strong Trust contract. This has become known as an Exchange, a provision of a purchase and sale agreement that states that the buyer or seller intends to make a 1031 exchange and reserves the right to assign its stake in the purchase and sale agreement to a qualified intermediary. The clause also generally requires other parties to help sign the applicable 1031 documents. Cooperation clause and it was a good policy at the time. There is no doubt that, in the vast majority of cases, an assignment of contractual rights to the qualified intermediary (QI) must take place as part of the exchange process. It is clear in IRS Regulation 1.1031(k)-1(g)(4)(iv) and (v) that „if a party to the agreement is assigned to the agent and all parties to that agreement are notified in writing of the assignment no later than the date of the corresponding transfer of ownership,” the IQ will be treated as the conclusion of the agreement. (The assignment document and notification to all parties are usually provided by QI.) When reviewing your contracts for the allocation of replacement goods, you may come across a frequently included section that reads as follows: „The exchanger intends to assign its rights, but not its obligations, over the replacement property.” What does this mean exactly? If the 1031 CORP. as an IQ, he initiates the 1031 exchange by preparing an exchange agreement that describes the relationship between the exchanger and the IQ. Some of the key elements of an exchange agreement are highlighted below: Although there is no regulatory requirement that there must be a 1031 addendum to the contract, it is sometimes suggested that such an agreement be introduced based on the contract price and all the terms have been agreed in the basic contract.
Although many exchangers typically include a language in their purchase and sale agreement to justify their intention to make an exchange, this is not required under the Internal Revenue Code. Many exchangers and real estate agents add exchange language to the contract for several reasons: we are also required to inform the buyer of the abandoned property and the seller of the replacement property of the exchanger`s intention to complete a 1031 exchange. The notice must be in writing, but the buyer and seller are not obliged to sign it. .