If you’re selling investment property and planning a 1031 exchange to defer capital gains taxes, you’ll hear about something called a Tax-Deferred Exchange Agreement. It’s not just paperwork — it’s a critical legal document that ensures your transaction actually qualifies for the tax deferral allowed under IRS rules. Without it, your exchange could fail, and you’d owe taxes you meant to defer.
So, what does the Tax-Deferred Exchange Agreement actually do? Let’s break it down.
What Is a Tax-Deferred Exchange Agreement?
The Tax-Deferred Exchange Agreement (sometimes just called the “Exchange Agreement”) is a formal, written contract between you — the taxpayer — and a Qualified Intermediary (QI).
It lays out the legal framework needed to:
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Transfer the relinquished property (the one you’re selling)
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Hold the proceeds from the sale (you cannot touch the money!)
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Buy the replacement property (the one you’re acquiring)
This agreement sets the ground rules that make the exchange “tax-deferred” instead of a taxable sale under the Internal Revenue Code Section 1031.
Why Is It Necessary?
Without the Exchange Agreement in place before you close on your sale, the IRS considers you to have sold your property for cash — and you’d owe taxes on the full gain.
The agreement ensures that you never have actual or constructive receipt of the sales proceeds, which is a fundamental rule for 1031 treatment.
It also documents that the sale and purchase are part of one continuous “exchange” transaction, not two separate deals.
What Does the Agreement Cover?
Typically, a standard Tax-Deferred Exchange Agreement will:
✅ Identify the Properties:
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Describe the relinquished property you are selling.
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Define the process for identifying and acquiring the replacement property (subject to 45-day identification and 180-day closing rules).
✅ Define the Role of the Qualified Intermediary:
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State that the QI is responsible for coordinating the sale and purchase.
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Assign your rights in the sales contract to the QI (this is known as “assignment of contract rights”).
✅ Control the Funds:
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Require that the QI holds the sale proceeds in a separate, segregated account.
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Ensure you never take possession of the money, even briefly.
✅ Outline Timelines:
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Set the strict IRS timelines:
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45 days to identify your replacement property.
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180 days to complete the purchase after selling the relinquished property.
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✅ Protect Tax Status:
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Clarify that the exchange must be completed according to Section 1031 rules.
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Include language protecting you (and the QI) from mistakes that would trigger taxable events, wherever possible.
✅ Fees and Responsibilities:
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Outline the fees you’ll pay to the QI for handling the exchange.
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Specify who covers legal, escrow, and administrative costs.
In Simple Terms:
The Tax-Deferred Exchange Agreement connects all the pieces — your sale, the handling of funds, the purchase of your new property — under one official, IRS-compliant structure. It is the legal and operational glue that turns two transactions into a true 1031 “exchange” — and helps you defer taxes that could otherwise cost you a huge chunk of your proceeds.
