Direct Deeding Under IRC Section 1031

For those mildly familiar with a Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange , it is generally well understood that in a typical exchange, the Exchanger sells the Relinquished Property to the Buyer with the assistance of a title or escrow company or some other settlement agent. Most know that Replacement Property must be identified within 45 days of the sale and acquired within 180 days (or less due to the filing date for the year’s tax return, unless extended). Parties also know that the use of a Qualified Intermediary is highly advisable to assure compliance with IRC § 1031. However often (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger s or their advisors are unsure how the flow of deeds takes place under a delayed exchange following the 1991 Treasury Regulations on the subject. 

Evolution of Deeding in a 1031 Exchange 

Property Prior to The Starker Case 

The Starker case ushered in the modern era of tax deferred exchanges in the early 1980s.  Prior to that time, it was thought that an exchange had to be simultaneous. As part of a single closing transaction, the Exchanger sold and conveyed the Relinquished Property to his The purchaser of the taxpayer's relinquished property. Buyer , in lieu of cash payment, which resulted in the The purchaser of the taxpayer's relinquished property. Buyer obtaining the Exchanger’s target property from its Seller and arranged for the The purchaser of the taxpayer's relinquished property. Buyer to transfer said property as Replacement Property to the Exchanger. As a result, the Exchanger and the The purchaser of the taxpayer's relinquished property. Buyer completed an exchange. The Starker case changed everything when the Court held that nothing in IRC §1031 required that the sale and purchase had to be simultaneous. It wasn’t until the legislative response in the Tax Act of 1984 that the 180-day exchange period was added to the Tax Code, prior it was open ended under the Starker ruling. 

Following The Starker Case Decision 

The period between the Starker decision and 1991, due to the ability to complete a transaction on a delayed basis, brought up a myriad of unanswered questions including how to handle deeding of properties when an exchange is delayed. The original Code Section from 1921, as amended, did not really contemplate non-simultaneous structures. Given the confusion, it was unclear how legal title had to flow where the exchange was on a delayed basis. The Starker case involved a five-year window for the The purchaser of the taxpayer's relinquished property. Buyer to acquire and transfer Replacement Property back to Starker. In The Tax Reform Act of 1984, Congress amended Section 1031 to limit the time to receive Replacement Property from the The purchaser of the taxpayer's relinquished property. Buyer to the current period of 180 days. 

Deeding in a 1031 Exchange Post 1991 Regulations 

By providing the Regulations, the drafters attempted to answer all the open questions and to provide some certainty around the necessary process of an Exchange, including how to deed the title. This entailed making sure that that an actual exchange was still taking place, not simply a sale followed by a purchase within a certain time period, as well as making the exchange process as seamless as possible. A significant part of this was introducing the concept of the Qualified Intermediary (QI), who could substitute for the The purchaser of the taxpayer's relinquished property. Buyer as a party with whom the Exchanger could exchange properties. 

The primary purpose of a QI was to take the The purchaser of the taxpayer's relinquished property. Buyer out of any necessary participation in the Exchanger’s exchange transaction. In other words, the The purchaser of the taxpayer's relinquished property. Buyer did not have to acquire Replacement Property from a third-party seller and transfer it to the Exchanger. 

QI Taking Tax Ownership to Properties 

The Regulations set forth several ways for the QI to meet the obligation of exchanging with the Exchanger. The first one is: “An intermediary is treated as acquiring and transferring property if the intermediary acquires and transfers legal title to that property”. Compliance with this provision means the QI takes legal title by deed from the Exchanger and deeds the Relinquished Property to the The purchaser of the taxpayer's relinquished property. Buyer and takes legal title by deed from the Seller and deeds the Replacement Property to the Exchanger.   

Assignment of Rights in Lieu of Deeding to the QI 

Under the Regulations, if the QI joins the seller as a named party under the Relinquished Property Contract, and similarly, joins the buyer as a named party under the Replacement Property Contract, that is all that is necessary. But a far easier alternative exists to make the necessary nexus between the (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger and QI. This option entails the (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger to assign the rights under the sale and purchase agreements to the QI and provide written notice to all parties to the agreements of the assignment. This is the option that is most commonly used. It does from time beg the question, when using the “assignment of rights” process does it require the QI to take title to the properties? 

The answer is No, it is not required; the Exchanger can issue a direct deed to the The purchaser of the taxpayer's relinquished property. Buyer of the Relinquished Property and receive a direct deed from the Seller of the Replacement Property. The availability of a direct deed is inferred from the Regulations as well as explicitly referenced in several IRS Rulings. It is interesting to note that Like-Kind Exchanges section of IRS Publication 544 (2023), Sales and Other Disposition of Assets tracks the language of the Regulations generally but explicitly adds the parenthetical underlined below: 

An intermediary is treated as acquiring and transferring the property you give up if the intermediary (either on its own behalf or as the agent of any party to the transaction) enters into an agreement with a person other than you for the transfer of that property to that person and, pursuant to that agreement, that property is transferred to that person (that is, by direct deed from you). An intermediary is treated as acquiring and transferring replacement property if the intermediary (either on its own behalf or as the agent of any party to the transaction) enters  into an agreement with the owner of the replacement property for the transfer of  that property and, pursuant to that agreement, the replacement property is transferred to you (that is, by direct deed to you). 

The ability to maintain a valid Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange while still being able to direct deed properties between the Buyers and Sellers of an exchange not only simplifies the exchange process but can also be helpful to avoid transfer taxes that can occur when title work is involved, as well as avoid potential liabilities attached to properties such as environmental issues. Should a QI, or other party, have to take direct deed to a property and absorb its liabilities, even just for a matter of time, that could cause friction in an Exchangers ability to acquire desired properties. 

An additional outcome of the Regulations and introduction of the QI was that the Regulations made it very clear that during the pendency of the exchange, the (“Exchangor” or “Taxpayer”) Person intending to conduct a 1031 tax deferred exchange, who transfers a relinquished property and thereafter receives a replacement property. Exchanger could not be in actual or constructive receipt of the sale proceeds, also termed exchange funds. Contrary to public belief, the primary purpose of the QI was not to hold the funds during this period, rather the Regulations set forth five different alternatives to hold funds in an acceptable manner. None of them included reference to the QI holding them, but by practice this became the simplest and most common way to protect the funds, which holds true today.   

At one time, to effectuate an exchange the Exchanger and the Buyer had to trade deeds, even if the Buyer acquired the trade property via a deed from a third-party Seller. The Starker case opened a new door from simultaneous exchanges to delayed exchanges, resulting in the need for additional clarification which were addressed in 1991 by the Regulations. Although past practice and the Regulations both approved the passing of deeds between the parties, the Regulations also sanctioned direct deeding by utilizing a QI and the “assignment of rights” process which simplified a Internal Revenue Code Section 1031 states that "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment." 1031 Exchange and provided protections for all parties involved. 

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified A person acting to facilitate an exchange under section 1031 and the regulations. This person may not be the taxpayer or a disqualified person. Section 1.1031(k)-1(g)(4)(iii) requires that, for an intermediary to be a qualified intermediary, the intermediary must enter into a written "exchange" agreement with the taxpayer and, as required by the exchange agreement, acquire the relinquished property from the taxpayer, transfer the relinquished property, acquire the replacement property, and transfer the replacement property to the taxpayer. Intermediary , and as such does not offer or sell investments or provide investment, legal, or tax advice.