An IRS 1031 exchange, also known as 1031 exchange or like-kind exchange, is a tax-favored transaction where the seller can take the proceeds from the sale of a property and reinvest it into another replacement property to defer capital gains or losses that otherwise would have been realized at the time of the sale. The process can go smoothly if done correctly, but missteps can lead to legal consequences, loss of the financial gain, or a failed transaction. The Texas Real Estate Research Center recently published an article that addresses eight mistakes that can occur when participating in a 1031 exchange. Here are some of those mistakes:
Waiting Too Long
When attempting a 1031 exchange, advanced planning is essential. Like-kind exchanges are specifically for properties held for trade or business use or for investment purposes. Clients should consult with their own tax advisors or tax or real estate attorneys on whether a 1031 exchange will be beneficial for them and to ensure the replacement property meets the 1031 criteria. Real estate attorneys and title officers point out that sellers can miss out on these opportunities by not being aware of 1031 exchanges till closing, but by then, it is too late.
Replacement Property Downfalls
In a 1031 exchange, a seller has 45 days to choose a replacement property, which can be a short amount of time concerning identification, negotiation, and financing of the property.
Sellers should be aware of this 45-day window, keeping track of the exact deadline and if it falls on a holiday or a weekend.
Another blunder sellers make is not having multiple replacement properties identified. Sellers can miss out on a deadline due to revoking the identification of a property late in the 45-day window and not having a secondary property to invest in.
The Importance of a Qualified Intermediary
Being a part of a 1031 exchange can put sellers at risk if everything does not go smoothly. It is important to have not just anyone overseeing the transaction but a highly qualified intermediary who has a good reputation and experience. Failure to do so can result in a mismanagement or loss of funds or a breach of contract lawsuit. Identifying a qualified intermediary can be difficult due to an unregulated marketplace. Sellers should contact private intermediaries, tax advisors, tax attorneys or real estate attorneys, for these types of transactions and for help in identifying qualified intermediaries who can assist on such transactions.
Read the full article discussing other mistakes sellers make while completing a 1031 exchange.