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Tax-Deferred Exchanges Part 2: Trust Agreement

August 22, 2017 Douglas Davis

In our last blog, we discussed the limitations of a Tax-Deferred Exchange – a technique available to defer taxes and maximize the funds available for reinvestment upon the sale of an investment property.

Because there are many considerations with a Tax-Deferred Exchange, we are covering the topic over the course of three blogs. Today we’ll be discussing the Trust Agreement aspect of a Tax-Deferred Exchange.

Trust Agreement

The Tax-Deferred Exchange Trust Agreement is the heart of the property swap and should be prepared in advance of the exchange for the Replacement Property. Once the closing for the “sale” of the Relinquished Property has occurred, it is the Trust Agreement that survives. The net proceeds normally paid to the taxpayer would instead be paid by the settlement attorney to a “Qualified Intermediary” who holds the funds pending acquisition of Replacement Property. The Qualified Intermediary later disburses the funds either a) to acquire new Replacement Property designated by the taxpayer, or b) to the taxpayer at the termination of the trust.

When the Qualified Intermediary serves as trustee for the taxpayer, then at the Relinquished Property settlement the taxpayer deeds the Relinquished Property directly to the buyer using an “Exchange Deed” with normal recording fees. The taxpayer is then responsible for identifying Replacement Property by providing notice to the Qualified Intermediary within 45 days of the Relinquished Property closing. Provided that closing on the Replacement Property occurs within 180 days of the Relinquished Property closing, the seller of the Replacement conveys the property by exchange deed directly to the Taxpayer, thereby completing the exchange.  The taxpayer’s tax basis in the Replacement Property will be his old basis in the Relinquished Property, plus the costs of its sale/exchange, plus any increased price of the Replacement Property over the Relinquished Property, plus its closing/exchange cost, less boot received by liability relief from a lower mortgage or any cash not reinvested from the Trust.

As you can see, setting up and enacting a Trust Agreement for a Tax-Deferred Exchange can be a complicated process that has very strict and specific requirements. The best way to use this system to your investment advantage is to work with a qualified estate and trust administration attorney.

In our final blog on the topic, we’ll discuss practical considerations for your Tax-Deferred Exchange.

This article is intended only for the purpose of providing general information and does not constitute legal advice. By providing this information we are not establishing an attorney-client relationship and nothing contained in this article should be construed to necessarily be applicable to your unique situation. You should always engage the services of an attorney to determine which, if any, legal solutions are right for you.

Davis Law Group