When you are exchanging property under a 1031 Tax Deferred Exchange, you may choose to “direct deed” your property to the buyer or have the seller direct deed his property to you. Direct deeding is achieved by deeding your property directly to the buyer rather than to an intermediary, which initially was the common practice in 1031 tax deferred exchanges. The seller of the property which you are buying then deeds his property directly to you, skipping the deed to an intermediary.
An IRS ruling in 1990 provided that it was no longer necessary to use “sequential” deeding in a tax-deferred exchange transaction. Under sequential deeding, a deed from the Seller was given to an intermediary who then deeded the property to the buyer. Most property transfers in tax-deferred exchanges today use “direct deeding” rather than “sequential deeding.”
Using direct deeding reduces the risks involved to an intermediary, who would be in title for a short period of time and exposed to risks of liability for asbestos or other environmental hazards and the disclosures required for those risks. Direct deeding also eliminates the payment of duplicate transfer taxes which are normally charged each time a deed is recorded.
There are several safeguards you can use when direct deeding. Be sure that if you are using a qualified intermediary, that your intermediary has an agreement with your buyer for the transfer of the property to be exchanged. Also be sure that your intermediary has an agreement with the seller of the property you will be acquiring which allows for the transfer of that replacement property to you.
All parties to the agreement must be notified in writing of your intention to use an intermediary in the exchange. If you are using a qualified intermediary in your exchange, typically the intermediary will have an affiliation with a title or escrow company, which can then provide all the services required to handle the closing, such as title insurance, escrow services, and document preparation and transfers. There are several advantages to using a professional intermediary in your exchange.
These advantages include reducing the potential liability for the structure of the exchange and any tax consequences, shielding the principals from accepting additional liability, and providing an audible trail by way of the assignments and exchange agreements.
When choosing a tax deferred exchange, be sure to be aware of the tax regulations required to qualify the exchange under IRS tax regulations. These regulations will spell out how to identify your replacement property and how many properties you can identity, how you can structure the exchange, how to direct deed your relinquished property to your buyer, how you can receive remaining cash that you may not choose to invest in the replacement property, how to receive interest on your exchange balance in addition to how to handle the closing and other transaction costs.