1031 Exchanges: Special Year End Issues

Section 1031 of the Internal Revenue Code lets an investor delay capital gains taxes on the proceeds from the sale of property if (1) the proceeds are reinvested in a new property within 6 months and (2) a third party (a "qualfied intermediary") holds the funds in between the sale and new purchase.

However, if an investor closes on the sale of a property late in the year, then the 6 month period will end after April 15th of the following year. This can be an issue if the investor isn't ready to close on the replacement property or properties by then. The exchange needs to be reported in the tax filing for the year that the sale of the property occurred. Once an investor files the tax return for that year, it cannot be amended to address the 1031 exchange.  If the investor cannot close on the replacement property or properties by April 15th, then an extension needs to be filed to allow time the 1031 exchange transaction to be completed.

Other potential issues in the process relate to accessing any available cash from the sale that will not be put into the replacement property.  For example, if an investor purchases a replacement property but has leftover cash from the property sale, the cash can be accessed on April 16th, if the investor's tax return is filed on the 15th. However, if the investor files for an extension of its taxes to allow time to idenfiy and close on the purchase of replacement property, any leftover cash must remain the possession of the qualified intermediary. It can only be released upon the expiration of the 6 month exchange period or the new extended due date for its tax return, whichever is earlier.

Bottom line, not only is the assistance of the right attorney important when planning a 1031 exchange transaction, the services of a good accountant is even more critical.  1031 exchanges can be incredibly complex and even minor issues can derail the tax deferral benefits of the exchange.

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