Alexandra Hart and I are still amazed that we hear so many of the same myths and misconceptions every week about 1031 exchanges, what properties qualify and how exchanges work. Unfortunately, many of the myths result in someone not exchanging when a 1031 would have saved a significant amount of taxes. Here are two more myths that we hear as reasons not to do an exchange.
Myth No. 7
In order for a 1031 exchange to work, I have to find someone who has property I want and who wants my property.
Not true. The IRS has allowed so-called delayed or deferred exchanges for many years. For a number of years, no guidance existed on how to handle deferred exchanges. In the late 1970’s, the Starker case held that a 1031 exchange did not have to be simultaneous. Subsequently, the tax law was changed which allowed deferred exchanges, subject to certain limitations.
Now deferred exchanges are the norm. We very rarely see direct swaps of property, although they are certainly allowed. Most exchanges are effected by exchangers who sell their relinquished property to an unrelated third-party buyer and then purchase the replacement property from someone who is unrelated to either the exchanger or the buyer of the relinquished property. In fact, in many cases neither the buyer of the relinquished property nor the seller of the replacement property are doing 1031 exchanges. Although, in many cases they are.
The deferred exchanges must meet several simple rules. The exchanger must acquire the replacement property within the earlier of 180 days from the sale of the relinquished property or the due date of the tax return (including extensions). The exchanger must identify the potential replacement properties within 45 days from the sale of the relinquished property. And, lastly, the exchanger should use a qualified intermediary (QI) or other safe harbor to avoid receipt of the sales proceeds from the sale of the relinquished property. Following these rules, and a few others, will ensure a valid 1031 exchange.
Myth No. 8
If I fail to identify property within 45 days or if I fail to acquire sufficient replacement property during the exchange period, I will lose my money or be hit with severe penalties by the IRS.
Failure of an exchange results in no penalties and you will not lose your money. An exchanger who fails to identify any property during the 45-day identification period will have his or her exchange proceeds returned on Day 46. Likewise, an exchanger who fails to acquire any property during the exchange period will receive the exchanges funds on Day 181. Please click here to read more about at what points during the exchange period the exchanger is allowed to get their money back. The only economic loss is the fee charged by the intermediary, which is typcially minimal compared to the potential tax savings.
A failed 1031 exchange is treated merely as a sale of the relinquished property, subject to whatever taxes would have been imposed had a 1031 exchange not been attempted. Even better, the exchange that begins in one tax year and fails in the subsequent tax year is treated as an installment sale with the possibility of significant tax deferral. Click here for more information on the tax treatement of a failed exchange.
In any event, once sellers become aware of these realities, most realize that they have nothing to fear from a failed exchange and decide to enter into the exchange to preserve the right to defer taxes.
Stay tuned for more posts exposing the myths of 1031 exchanges that keep investors from saving taxes.
For more information on 1031 exchanges, contact Moore McLaughlin by e-mail at fmm@allstates1031.com or Alexandra L. Hart at ahart@allstates1031.com or by call toll-free at 877-395-1031.
