When engaging in a 1031 exchange, timing is everything. It is common for many folks to put off important decisions until the last moment, however when you decide to complete a 1031 exchange, you are often better off acting sooner rather than later.
The IRS provides specific guidelines for when you must identify and close on your replacement property. Fail to meet these guidelines, and your 1031 exchange will be disqualified, causing you to owe capital gains taxes on the entire transaction. Since the stakes are so high, it is critical to understand the requirements before initiating a 1031 exchange transaction. Here is what you need to know.
The first important deadline in a 1031 exchange is known as the “45-Day Rule.” It states that an investor must identify “like-kind” replacement properties no later than midnight on the 45th calendar day after the relinquished property’s closing date.
To meet the requirement, you must send a written notice to your qualified intermediary identifying the property(s) you plan to purchase. This notification may be delivered by fax, mail, or overnight courier. It’s important to note that the rule is based on calendar days. This means that if your 45th day falls on a weekend or a holiday, your due date will not be extended to the next business day.
Since the 45-day period will go by quickly, we encourage clients to begin exploring replacement property options well before the closing date of their property. Unfortunately, this is set in stone. You cannot extend due dates for any reason unless the U.S. President declares a natural disaster that impacts the parties or properties involved in the exchange. It is also not possible to back-date or otherwise alter your notification to try to get around the 45-day rule. Doing so is considered criminal tax fraud and can result in severe fines and penalties. It is advisable to avoid any qualified intermediary that suggests this is an option.
If you are concerned about identifying a replacement property too soon, you do have some protection. The 1031 exchange rules allow investors to formally revoke a replacement property identification and submit a new identification form at any time during the 45-day period. However, after the 45-day period has passed, you cannot make further changes. It is also important to note that revoking a property identification does not reset or extend the 45-day period.
Replacement properties must be precisely identified by name and address. A generic property identification e.g., “single family rental” is insufficient. If a DST is listed, the percentage ownership and portion of debt and equity that will be acquired is also required by many qualified intermediaries.
Once you have formally identified your replacement properties, you’re halfway there. Next, you’ll need to ensure you complete the 1031 exchange transaction on time. The 180-day rule states that investors must receive title to all like-kind replacement properties no later than the earlier of:
1. Midnight on the 180th calendar day following the closing of the sale transaction on the relinquished property, or
2. The due date of your Federal tax return for the year in which the sale of the original property occurred, including extensions.
If you closed on your relinquished property sale anytime between January 1st and October 16th, then you won’t need to worry about the second condition. You’ll need to make sure you close on all replacement properties within the 180-day period.
If you sold your relinquished property between October 17th and December 31st, things get a bit more complicated. In this case, you may need to file for an extension on your tax returns if you haven't completed your transaction by the tax filing date. Once you do this, you’ll still need to complete your transaction within the original 180-day period, then file your income taxes.
Whether you file for an extension or not, you’ll never have more than the original 180 days to complete your 1031 exchange transaction (unless by an IRS approved exception due to an unusual event). Just as with the 45-day rule, if you fail to meet the 180-day rule, you’ll lose your tax-deferred status, and the transaction will be re-characterized as a taxable sale.
FGG1031: Your 1031 Exchange Experts
Understanding the timeline requirements for a 1031 exchange is a critical first step to a successful exchange. However, there are other important requirements you need to know. If you’re considering engaging in a 1031 exchange, consider seeking expert advice. This will help ensure you don’t unintentionally make a costly mistake.
FGG1031 provides one-on-one guidance throughout the entire 1031 exchange process, including assisting investors with selecting a suitable replacement property. To learn more, contact us today.