Managing 1031 Exchange Deadlines Without Costly Misstep

One of the most effective tools that real estate investors have is a 1031 exchange that enables you to avoid the capital gains taxes on your hands by investing the proceeds of a sale into a similar-purpose property.

Although it is a federal provision, it is a race against time that has no room for error, and the deadlines are strict. Any wrong move will potentially trigger a huge tax bill, transforming a brilliant investment plan into a nightmare. Always prefer contacting tax professionals for sales tax audit representation and similar work.

Dates You Shouldn’t Forget

There are two strict time limits stipulated by the IRS that are never compromised. Cold feet, cold markets, and colds do not have extensions.

a)     The 45-Day Identification Period

You must actually designate the potential replacement property or properties in writing within 45 calendar days beginning on the day you close the sale of your original property (the "relinquished property): Weekends and holidays count.

b)     180-Day Purchase Period

Within 180 calendar days of the sale of your relinquished property, you have to close on the purchase of your replacement property.

More importantly, these periods are not sequential, but parallel to each other. Within the 180 days are the 45 days.

Check the Specific Pitfalls in California

The most important regulation to remember is that in order to freeze the clock on these federal deadlines, your sale proceeds should not be under your control. This is the point of failure of many investors.

a)     Learn about Cardinal Sins

So long as the funds of the sale are received by you or your agent, even for a single instance, the whole transaction is voided. IRS and California Franchise Tax Board (FTB) will regard it as a taxable sale.

b)     What is the Solution?

Before closing on the sale, you have to employ a QI. The proceeds are kept in another account by the QI so that you do not ever have the funds in constructive possession. The selection of a good QI that has a good reputation and a good financial standing is not negotiable. After hiring tax experts (from a tax resolution law firm), the chances of tax mistakes will be low.

Rules You Must Follow During the Replacement Property

You cannot simply find any property: you have to obey one of three strict rules:

1.      Determine as many properties as possible that are not yet subject to a total market value. This is the most widespread and simple rule.

2.      Establish any amount of property, provided that the total fair market value of all of the property combined does not exceed 200 percent of the value of the property that is relinquished.

3.      On any property you wish to acquire, you need to identify a total of at least 95 percent of the total value of all the properties identified.

Tips That Will Help You Exchange Smoothly

a.      Schedule to get your QI in place and start researching any potential replacement property before even listing your relinquished property for sale. The 45-day clock is not long enough to start afresh.

b.      This is required to be in written form, it should be signed by you and sent to the QI (or other party named in the exchange agreement) before the end of the 45th day. Email is not a problem, but make sure that you receive a delivery receipt.

c.       As much as California also imposes no capital gains tax or reduced capital gains tax, in the event that you sell your replacement property in a state with no or lower capital gains tax, California can impose the deferred tax on the part of the gain that originally was earned in California. This predetermines the necessity of careful long-term planning.

The 1031 exchange is an effective deferral method, which works on the edge of a razor. In order to overcome the crisis of time crisis, you can employ a professional intermediary, adhere to the schedule, and take your time, which will enable you to keep your capital at work.