Simultaneous 1031 Exchange

The simultaneous exchange is the oldest method of performing an IRC §1031 tax-deferred exchange. There are basically three ways to perform a simultaneous exchange:

1. Swap or Two-Party Trade: Two parties exchange (“swap”) deeds with each other. Advantages: No need for a Qualified Intermediary. Disadvantages: Very difficult to find another party who wants to swap for your property. The other party has to want what you have at exactly the same time you want to acquire their property. Equity and debt must match on both properties to avoid one party recognizing some “boot.”
2. Three-Party Exchange: An “accommodating party” is used to help facilitate the transaction for the Exchanger. In the Alderson format, the title is passed through the Buyer. In the Baird format, the title is passed through the Seller. Advantages: No need for a Qualified Intermediary. Disadvantages: There are many disadvantages to this approach. Most legal and tax advisors strongly discourage their clients from utilizing this method. One of the main reasons this approach is discouraged is that the “accommodating party” actually takes title to a property that they know nothing about. Since this party is on the chain of title, they are exposed to any issues associated with that property, including the potential to be involved with environmental issues. In addition, there is very little documentation besides the recording of the deeds to support that an exchange had been structured.
3. Simultaneous with a QI: A Qualified Intermediary is used to structure the 1031 tax-deferred exchange. Advantages: The 1991 Treasury Regulations state that the only “safe harbor” for a simultaneous exchange is using the services of a Qualified Intermediary (“QI”). The QI provides written instructions to the closing officers, prepares the exchange agreement and other exchange documents, and insulates the Exchanger from any “constructive receipt” issues. In addition, this format can be easily converted to a delayed exchange and eliminate the time pressure of trying to close the entire transaction simultaneously. Disadvantages: Nominal cost for the QI services.

Even if properties close on the same day, one of these three methods must be used to perform a valid transaction. It is not sufficient to merely wire proceeds from the sale closing to the purchase closing on the same day and obtain tax deferral. If the Exchanger has a “constructive receipt” of the funds, even if only for a few minutes or hours, the transaction no longer qualifies for tax deferral.

One of the requirements for a valid IRC Section 1031 tax deferred exchange is the actual exchange of one property for another property. To qualify for tax deferral, an Exchanger must never have either actual or constructive receipt of the exchange proceeds at any time after closing on the sale of the relinquished property.

Unless an Exchanger is performing either a two-party or three-party simultaneous exchange, a Qualified Intermediary (QI) must be used to make sure the Exchanger does not have access to the proceeds in any manner. Reflected below are some examples where Exchangers who intended to perform a simultaneous exchange ultimately failed to have their transactions qualified for a 1031 tax-deferred exchange.

One of the main advantages of a Simultaneous 1031 Exchange is that it allows an investor to defer paying capital gains taxes on the sale of their property. This can be particularly useful for investors who have a significant amount of equity in a property and want to avoid paying taxes on the gain. By using the proceeds from the sale to purchase a new property, the investor can effectively roll over their equity into a new investment without incurring tax liability.

Another benefit of a Simultaneous 1031 Exchange is that it allows an investor to trade up to a more valuable property without incurring a tax liability. This can be particularly useful for investors who want to expand their real estate holdings or who want to invest in a property in a more desirable location. By using the proceeds from the sale to purchase a more valuable property, the investor can effectively leverage their existing equity to acquire a better investment.

A Simultaneous 1031 Exchange can also be useful for investors looking to diversify their real estate portfolio. By selling a property and using the proceeds to purchase a new property in a different market, an investor can reduce their exposure to any single real estate market. This can help to spread risk across different regions and asset classes, which can be particularly useful in uncertain economic times.

While a Simultaneous 1031 Exchange can be a useful strategy for deferring tax liability and diversifying a real estate portfolio, it can also be a complex process that requires careful planning and execution. Investors should work with an experienced real estate attorney and tax professional to ensure that the exchange is structured properly and complies with all IRS regulations. Additionally, investors should carefully evaluate the potential risks and benefits of the exchange before moving forward to ensure that it aligns with their overall investment goals and objectives.

Simultaneous 1031 Exchange Court Judgements

Allen, Joyce, (1982) TC Memo

The Tax Court held that a multi-party exchange using two escrows was a sale, followed by a purchase because neither of the escrows was made subject to the successful completion of the transaction in the other escrow.

Klein, Keith, (1993) TC Memo

The Tax Court held that a multi-party transaction involving an escrow account was a sale followed by a reinvestment, rather than a valid tax-deferred exchange because the Exchanger had unrestricted control over, and thus constructive receipt of, the funds in the escrow account. Although the escrow agreement assigned some of the escrowed funds (from the sale of the Exchanger’s relinquished property) to a third party (the person from whom the Exchanger was acquiring the replacement property), those instructions were made at the Exchanger’s “own behest.” The deal between the Exchanger and the purchaser of his property involved no restrictions on the Exchanger’s control of the sale proceeds that were to be deposited into the escrow account. Thus, at the time that the purchaser deposited the funds in escrow, the Exchanger had control over them.

Florida Industries Investment Corp. (1999) TC Memo

A Corporation intending to perform an exchange failed to prove that it, acting through its president, did not have control over the escrowed sales proceeds, thus the exchange didn’t qualify as a tax-deferred exchange. Although the sales agreement imposed restrictions on the corporation’s access to the escrowed sales proceed until the expiration date of the 180-day period, the escrow agent (also, the corporation’s lawyer) violated the terms of the agreement and permitted the president to control the disbursement of the funds for purposes other than the acquisition of replacement property, such as a “draw” to the president. Also, on several occasions, the agent signed checks to pay off balances due with respect to the acquisition of replacement properties, and amounts in excess of those balances due were not re-deposited in the escrow account.

Maxwell Mark V. U.S. (1988)

A district court held that a multi-party exchange using an escrow was a sale and not a tax-deferred exchange where the Exchanger had the discretion to terminate the escrow before using the exchange proceeds for purchasing the replacement property that was to be transferred back to the Exchanger.