Tax Mitigation Playbook: 1031 Exchange Pitfalls to Avoid

Financial Planning Dentist

Excess Funds

The identification period of a 1031 exchange refers to the first 45-days when a taxpayer identifies property they would like to acquire as a replacement to their relinquished property. It is common for a taxpayer to identify more than one potential replacement property, but only purchase one. 

If there are excess funds in the exchange account, the QI can return them once an exchange is complete. If the taxpayer has identified more than one potential replacement property the excess funds must remain in the exchange account until the end of the 180-day exchange period. Receiving funds before the end of the exchange period could jeopardize the entire exchange. 

Early Release of Funds

If a taxpayer decides not to move forward with an exchange, they must acknowledge to their QI that they understand they will pay all applicable taxes on the gain. Even so, exchange facilitators are only permitted to disburse funds at particular times for particular reasons. 

The only time someone can terminate an exchange early is at the end of the 45-day identification period. If the taxpayer has not identified a single property by 45 days, they can close their exchange, and the funds can be disbursed. 

If the taxpayer has identified any property, funds must be held until the transaction is complete or at the end of the 180-day exchange period. Suppose an exchange facilitator is found to be deviating from the rules. In that case, failure to comply with regulation could jeopardize any of this taxpayer’s previous exchanges and any other exchanges facilitated by the company.

1031 Exchange Timeline

“Can I start a 1031 exchange after I’ve sold my property?” or “I just closed on my property; can I still do an exchange?” There are a few variations to this question, but ultimately the answer is always the same. No. 

Once you’ve sold and closed on a property, it is no longer eligible for exchange. The taxpayer cannot take actual possession or control the net proceeds from the sale of a relinquished property in a 1031 exchange. An exchanger must contact a QI before selling their property. 

If you find yourself short on time or at the closing table, don’t lose hope with processing an exchange. With the InSight 1031 relationship and Accruit (our technology and service partner) speed and experience The transfer of the relinquished property to the Qualified Intermediary, and the receipt of the replacement property from the Qualified Intermediary is considered an exchange. 

To be compliant with IRC Section 1031, the transaction must be properly structured, rather than being a sale to one party followed by a purchase from another party.

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