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Phase 1 (Down Leg)

The term “Down Leg” refers to the sale or relinquishment of the investor’s original or “relinquished” property. The 1031 exchange allows an investor to defer capital gains taxes by selling one investment property and acquiring another “like-kind” replacement property.

The 1031 exchange process can be broken down into two main segments:

  1. Down Leg: This is the first leg of the exchange where the taxpayer sells the relinquished property. The proceeds from this sale are typically held by a qualified intermediary (QI) rather than being given directly to the seller to ensure the exchange remains compliant with Section 1031 of the Internal Revenue Code.
  2. Up Leg: This is the second part of the transaction, in which the taxpayer acquires the “replacement” property. The taxpayer has a total of 180 days from the sale of the relinquished property to close on the acquisition of the replacement property. This portion is sometimes called the “buy phase” or “up leg” of the exchange.

It’s essential that specific requirements be met for a transaction to qualify for tax deferment under a 1031 exchange. For instance, from the date of closing on the down leg, the investor typically has 45 days to identify potential replacement properties and 180 days to complete the acquisition of the replacement or “up leg” property.

If done correctly, the taxes that would have been due upon the sale of the relinquished property are deferred, as long as the funds are kept in escrow by a qualified intermediary and not received directly by the seller. The investor can then use the entire sales proceeds towards the purchase of the replacement property, potentially allowing for a larger or more valuable acquisition.