Don’t Jeopardize Your 1031 Exchange

What might you be guilty of doing that could potentially disqualify your 1031 exchange transaction? Here are a few reasons you could be putting your exchange at risk.

Choosing a Qualified Intermediary that is actually a disqualified person. Someone who is acting as your agent at the time of the transaction is disqualified from acting as a Qualified Intermediary. Who is considered an agent? Someone who has acted as your employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the two-year period ending on the date of transfer of the first of the relinquished properties. These persons are disqualified because they are presumed to be under the Taxpayer'­s control and when the Taxpayer has control of the exchange funds, this is constructive receipt. Constructive receipt invalidates the 1031 exchange. See here for exceptions to this rule.

If exchange funds are set aside or otherwise made available to you, it is considered constructive receipt. Additionally, if you actually receive the exchange funds or if you benefit economically from the exchange funds you could invalidate your exchange.

The most common reason an exchange fails, though, is missed deadlines. The replacement property(ies) must be identified by midnight of the 45th day. Therefore, it is advisable to begin searching for the replacement property as soon as possible. In addition, the replacement property must be received by the taxpayer within the exchange period which ends within the earlier of 180 days from the date on which the taxpayer transfers the first relinquished property, or the due date for the taxpayer's federal income tax return for the taxable year in which the transfer of the relinquished property occurs. See here for exceptions to these deadlines.

Another not-so-commonly known mistake someone could inadvertently make would be to change the manner of holding title from the relinquished to the replacement property. There are a variety of reasons you might want to do this in an exchange and some changes are allowed, but you must be sure to talk it over with your tax advisor first. You can read further details on vesting title in a 1031 exchange, here.

You must also give serious consideration to any relationship you might have with the seller of the replacement property. Acquiring replacement property from a related party is potentially problematic, and the facts of the transaction should be reviewed by your tax advisor before proceeding. The IRS could view the acquisition as an abusive shift of bases between related parties resulting in tax avoidance and disallow the exchange. Also, direct swaps between related parties are allowed, but both parties must hold their newly acquired properties for at least two years from the date of the last transfer in the exchange. For more information on exchanging with related parties, click here.

First American Exchange has helped thousands of taxpayers successfully complete even the most difficult transactions. While we don’t provide tax or legal advice, we make it our business to keep you informed of your exchange deadlines and other potential pitfalls that could put your exchange in danger of not qualifying.

Attend Our Complimentary 1031 Exchange Webinars

The Basics of the 1031 Tax-Deferred Exchange
Tuesday, July 27, 2010

1031 Exchanges and the Settlement Agent
Thursday, July 29, 2010

For more information or to register, go here.

Like-Kind Requirements for 1031 Exchanges Explained

Internal Revenue Code Section 1031 applies only to "property held for productive use in a trade or business or for investment". (IRC section 1031(a)(1)). It allows for the deferral of capital gain tax if such property is exchanged solely for property of "like-kind". Contrary to what many people believe, "like-kind" does not mean that an investor must, for example, exchange land for land, or a duplex for a duplex. In the context of real estate, like-kind exchanges are valid between and among several different types of investment property, including bare land, commercial property, industrial buildings, retail stores, apartments, duplexes-even leasehold interests exceeding 30 years and certain oil and gas interests.

Flexibility and Diversification

The liberal definition of "like-kind' in real property exchanges means significant advantages for the investor who elects to perform a 1031 exchange. For example, when raw land is traded for a small retail center, capital gain taxes can be avoided, and the investor will also reap the benefits of owning a property that will generate increased cash flow. Another advantage in this example...read on.