Completing a 1031 exchange requires sharp attention to detail. This includes meeting all IRS deadlines. For example, many real estate investors know the rules requiring the investor to identify a replacement property or properties within 45 days and close within 180 days of the sale. However, if you’re planning on engaging in a 1031 exchange towards the end of the calendar year, you also need to be aware of several important tax considerations.
Before initiating your exchange, it’s critical to make sure you’re clear on the forms you’ll need to file, how tax filing deadlines may impact your timeline, and when to pay the required taxes if your exchange fails. Here’s a closer look at some important details you need to know:
How Tax Deadlines Impact the 180-Day Rule
The 180-day rule states that you must close on at least one of your identified replacement properties by the earlier of 180 days from the day you close on your relinquished property or the date when your tax return is due.
A 1031 exchange is reported by filing IRS Form 8824, which must be included in the tax return for the year in which your exchange begins. If you begin your exchange less than 180 days from the end of the calendar year, you may end up with a shortened timeline. However, you can address this issue by filing for a tax extension.
Filing for an Extension: What You Need to Know
If your 1031 exchange fails to close within the required 180-day period, you’ll owe taxes on the capital gains and depreciation recapture from the sale of your relinquished property. The year in which you’re obligated to pay these taxes depends on the date your relinquished property sold and the date when you took possession of the sales proceeds.
If your exchange began in one calendar year and failed in the next, you’ll have the option to pay the taxes when you file the current year’s return or wait until the next year. For example, if you began your exchange in 2021 and it failed in 2022, you could include the taxes owed on your 2021 tax return or wait until you file your 2022 return. However, it’s important to note that for this mini-deferral option to apply, you must be able to show that you did originally intend to complete a 1031 exchange.
Avoiding Failed Exchanges
A failed 1031 exchange can be a costly mistake. Unfortunately, the IRS rarely provides extensions for those unable to meet the 45-day and 180-day rule. Since there’s always a chance that a real estate transaction may be delayed or fall through, naming a Delaware Statutory Trust (DST) as one of your replacement properties, for example, can help you avoid losing your tax deferral.
DST’s are investment trusts that hold one or more pieces of real estate property and allow investors to purchase a fractional ownership interest. They are considered ready-to-invest properties and do not require loan qualification. This helps to minimize the risk that your selected DST won’t be available when it’s time to complete your exchange. Even if you plan to purchase a different replacement property, identifying a DST as one option can serve as an effective backup plan.
To learn more about 1031 exchanges and how they may fit into your investment strategy, schedule a consultation with our team. We’re happy to answer all of your questions and help you explore options for your replacement property.
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Because investor situations and objectives vary this information is not intended to indicate suitability for any individual investor.
DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney.