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.
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