A 1031 exchange, a potentially powerful tax-deferral strategy, allows you to defer capital gains taxes by reinvesting the proceeds from the sale of one property into another. It’s essential, however, to understand the rules and regulations to avoid disqualification. A misstep can lead to significant tax consequences. Before delving into disqualification, let’s briefly recap the 1031 exchange process: you must identify potential replacement properties within 45 days of selling the relinquished property; the exchange period, during which the closing of the sale of the relinquished property and the purchase of the replacement property must occur, typically lasts 180 days; and a neutral third party, such as a qualified intermediary (QI), must handle the exchange process to ensure compliance with IRS regulations.
As 1031 exchange specialists we will guide you through every step of the exchange process to ensure none of these below scenarios happen – from providing you with recommendations for skilled financial and real estate professionals and advisors to access to hundreds of like kind properties that can be purchased within the desired time frame.
Common Reasons for 1031 Exchange Disqualification
Improper Identification of Replacement Property
- Failing to identify the replacement property correctly or missing the 45-day deadline can lead to disqualification. This happens more than you might think. These are real-world examples of how investors have struggled with this part of the process:
- Investors who took the 45-day timeline for granted and waited until the last minute resulting in limited options available.
- They identified without the property(ies) being on the market, made an offer and then offers were not accepted.
- Inspections/due diligence of the property come back unacceptable and buyer and seller were unable to agree on repairs and/or concessions.
- Buyer was unable to secure acceptable financing terms or in time to close.
- Buyer didn’t replace debt from sale of the relinquished property. Read more about the rules and steps here.
- Struggled with securing insurance – a growing problem especially in locations prone to natural disasters like fire, hurricanes, etc.
- Didn’t have the right team in place to source real estate that met their needs, goals and objectives. Ensure your realtor is educated in 1031 exchanges and that you have a 1031 exchange expert at your disposal.
- Provided vague or incomplete details about the replacement property which led to disqualification.
Early Receipt of Funds
- If the seller takes possession of the sale proceeds, even temporarily, the 1031 exchange is invalidated, and the sale potentially becomes a taxable event.
- Using the funds for personal expenses or other purposes outside the exchange can also lead to disqualification.
Failure to Complete the Exchange Within the Timeframe
If the exchange isn’t completed within the 180-day exchange period, the transaction may be disqualified.
Improper Role of the Qualified Intermediary
- The QI must be involved in all aspects of the exchange, from identifying replacement properties to closing the transactions.
- If the QI engages in unauthorized activities or fails to follow IRS guidelines, the exchange could be jeopardized.
Personal Use of the Relinquished Property
Using the relinquished property for personal purposes, such as a vacation home, can disqualify the exchange.
Related Party Transactions
Transactions involving related parties, such as family members or business partners, may not qualify for 1031 exchange treatment.
How to Avoid Disqualification
To minimize the risk of disqualification, consider the following tips and call us for a free consultation. We are experts in 1031 exchanges, and we want yours to be successful!
- Consult with a tax professional
- Choose a reputable qualified intermediary. We are happy to provide references – contact us here
- Identify replacement properties within the appropriate IRS deadlines
- Avoid receipt of sales proceeds
- Stay informed about tax law changes
- Document everything
- Understand the rules for personal property
- Be mindful of boot
We have longstanding and vetted relationships with such critical professionals as QIs, CPAs, realtors, etc. Additionally, we have access to a database of properties available for exchanges and available during the necessary timeframes needed for a successful exchange. We are available for a free consultation to answer any questions you may have.
Diversified Investment Strategies is a team of seasoned professionals specializing in 1031 tax-deferred exchange solutions, offering customized strategies and expert analysis to identify potentially suitable investments, including DSTs, UPREITs, opportunity zones, TICs, NNN properties and oil & gas royalties. With a proven track record of hundreds of successful exchanges, we empower our clients to make informed investment decisions. Contact us at www.diversified1031.com or 949-379-2080.
*Example portfolio is hypothetical and for illustrative purposes only. Individual results will vary and are not guaranteed. Because investor situations and objectives vary this information is not intended to indicate that an investment is appropriate for or is being recommended to any individual investor. This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk. There are material risks associated with investing in private placements, Delaware Statutory Trusts (“DSTs”) and real estate securities including the potential loss of the entire investment principal, illiquidity, tenant vacancies impacting income and revenue, general and real estate market conditions, lack of operating history, interest rate risks, competition, including the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and investors should read the PPM carefully before investing paying special attention to the risk section. DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65). Individuals holding a Series 66 do not fall under this definition) 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. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Diversified 1031 is independent of CIS.
FOR ACCREDITED INVESTOR USE ONLY.