If you’re a real estate investor, you may be familiar with a 1031 exchange. This tax code allows property owners to defer capital gains tax by exchanging one property for another. In a simultaneous exchange, two property owners commit to this process with one another. While this arrangement is rare, it may be a process you can achieve.
What is a Simultaneous 1031 Exchange?
A simultaneous exchange involves two parties completing property closing on the same day and swapping properties for a capital gains tax deferral. Before the Internal Revenue Service (IRS) developed the 1031 tax code, simultaneous exchanges were the only type of exchange. The tax code has since changed to capture the 180-day timeline that allows for a delayed exchange.
These exchanges can be challenging to achieve because the timeline is stringent. Even with a delayed exchange, it can be challenging to identify a property within 45 days or close on a property that meets every requirement within the six-month time frame. A simultaneous exchange depends on finding a like-kind property owned by an investor who also wants to complete a 1031 exchange.
Types of Simultaneous Exchanges
The IRS recognizes three types of simultaneous exchange.
Swap or Two-Party Trade
The swap or two-party trade is the simplest form of the simultaneous exchange, but it’s also the more challenging type to complete. In this method, two parties hold properties that meet 1031 exchange requirements for one another. Each investor closes on the property on the exact same day, and they swap deeds with one another.
Money does not change hands in a two-party trade, only the deeds transfer. This method is challenging to achieve because an investor needs to find another property owner who wants exactly the type of property they have with the exact value to avoid boot.
A three-party exchange involves an accommodating party that facilitates the transaction between two property owners. This accommodating party acts as a bridge between you and your exchange property to meet all the requirements for a 1031 exchange. There are two formats for this exchange type:
- Alderson: The title transfers through the buyer. For example, you find a buyer for your property that does not have a property to exchange. You find a third-party seller with a suitable property. Your willing buyer purchases the property from the third-party seller and uses that property to complete the exchange with you.
- Baird: The title passes directly through the seller. In this case, you complete the 1031 exchange with the third-party seller, who then sells your relinquished property to the buyer you found.
This method can be easier to accomplish than a swap with the accommodating party. However, this process comes with risks. Typically, the third party will participate in this exchange with very little understanding of the property they’re accepting. This fact can make the party liable for problems with the property. There’s also limited documentation to support the exchange structure, which can lead to legal risks.
Simultaneous With a Qualified Intermediary
A simultaneous exchange with a qualified intermediary (QI) is similar to a standard 1031 exchange, but it still operates on a strict timeline. A property owner works with a QI to write the documentation for the closing officers and prepare the exchange agreements. The QI also protects the exchanger from construction receipt issues — requirements to pay taxes on income they have not received.
For this process to be a simultaneous exchange, the deeds still need to swap hands on the same day. However, the presence of a QI makes this process more flexible. If any delays occur in closing, the process can quickly become a delayed 1031 exchange and operate within the 180-day time requirement. With this method, both parties can still experience the tax deferral without simultaneous exchange.
The most notable disadvantage of this method is the costs for a QI. With the protections and the flexibility the QI adds to the process, it may be worth the additional expense.
Simultaneous Exchange Requirements
Being familiar with the general 1031 exchange requirements will help you complete a simultaneous exchange. However, since both parties involved want to qualify for the tax deferral, there are some notable differences.
Matching Equity and Debt
One of the most notable requirements in a 1031 exchange is the equal or greater value rule. In a simultaneous exchange, the concept of greater value doesn’t exist — the properties must have equal equity and debt.
In a one-way exchange, a property of greater value is appropriate because the investor is still spending the amount earned from their relinquished property. If a property owner tries to complete a simultaneous greater exchange, the other party will pay less for the exchange property than they earn for their relinquished property. This scenario results in boot that receives capital gains tax.
A true simultaneous exchange does not involve money changing hands in any capacity.
In addition to no money changing hands, property owners must swap deeds on the same day to complete a simultaneous exchange. Any delays in the closing process for either party can prevent a 1031 exchange from occurring.
The deed swapping requirement is why some investors choose to use a QI for their simultaneous exchange. If any administrative hurdles prevent swapping deeds on the same day, the process can easily convert to a delayed exchange with a series of protective documents.
When you strive to complete a simultaneous exchange in two different states or time zones, the deed swapping can become even more complex. Consider the risk of process delays when deciding what type of simultaneous exchange to complete.
Simultaneous Exchange Process
The simultaneous exchange process will depend on the method you choose to complete. Your first step for every method is finding another property owner with a like-kind property who wants to complete an exchange. From there, you either have to work with closing agents, engage an accommodating party, or work with a QI.
Regardless of the method you choose, your process and the process of the opposing property owner need to align for the exchange to be simultaneous.
Explore 1031 Exchange Opportunities
Completing a 1031 exchange is a way to invest in real estate while deferring capital gains taxation. Finding properties that work with an exchange is a significant aspect of this process, and it can be challenging to handle independently. At 1031 Crowdfunding, we support your investing goals. While we don’t execute simultaneous exchanges, we have a turnkey solution for 1031 exchanges that simplifies the process.
When you register at 1031 Crowdfunding, you gain access to our extensive inventory of 1031 properties. This inventory also includes Delaware Statutory Trusts (DSTs) to suit portfolio diversification. With our resources and professional support, you can identify a property in under a week and meet the timeline requirements.
Get started by registering for free today.
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