Missing Deadlines in a 1031 Exchange: Consequences and Remedies
A 1031 exchange is a complex process that requires careful planning and strict adherence to the rules and deadlines set forth by the Internal Revenue Service (IRS). If you find yourself missing deadlines in a 1031 exchange you’ll be in for a rough ride. Disqualification of the exchange and capital gains taxes are just the beginning.
In this post, we will explore what happens when you miss one or more of the time deadlines spelled out in the 1031 rules, as well as the consequences of over identifying or under identifying properties using the 3 property rule, the 200% rule, or the 95% rule.
45-Day Identification Period
The 45-day identification period is a critical deadline in a 1031 exchange. This is the timeframe during which the exchanger must identify the replacement properties they intend to acquire. The clock starts ticking on the day the relinquished property is transferred, and the exchanger has 45 calendar days to identify the replacement properties in writing.
What Happens if You Miss the 45-Day Deadline?
If the exchanger fails to identify the replacement properties within the 45-day period, the exchange is disqualified, and the taxpayer will be subject to capital gains taxes on the sale of the relinquished property. This means that the entire exchange will be treated as a taxable sale, and the exchanger will not be able to defer their capital gains taxes.
180-Day Exchange Period
The 180-day exchange period is another critical deadline in a 1031 exchange. This is the timeframe during which the exchanger must close on the replacement properties. The clock starts ticking on the day the relinquished property is transferred, and the exchanger has 180 calendar days to close on the replacement properties.
What Happens if You Miss the 180-Day Deadline?
If the exchanger fails to close on the replacement properties within the 180-day period, the exchange is disqualified, and the taxpayer will be subject to capital gains taxes on the sale of the relinquished property. This means that the entire exchange will be treated as a taxable sale, and the exchanger will not be able to defer their capital gains taxes.
Property Identification Rules
The IRS provides three rules for identifying replacement properties in a 1031 exchange: the 3 property rule, the 200% rule, and the 95% rule.
3 Property Rule
The 3 property rule allows the exchanger to identify up to three replacement properties, regardless of their value.
200% Rule
The 200% rule allows the exchanger to identify any number of replacement properties, as long as their total value does not exceed 200% of the value of the relinquished property.
95% Rule
The 95% rule allows the exchanger to identify any number of replacement properties, as long as they acquire at least 95% of the value of the properties identified.
What Happens if You Over Identify Properties?
If the exchanger identifies more properties than allowed under the 3 property rule or the 200% rule, the exchange will not be disqualified. However, the exchanger will only be able to acquire a limited number of properties, and the excess properties will be considered a “failed identification.”
What Happens if You Under Identify Properties?
If the exchanger identifies fewer properties than allowed under the 3 property rule or the 200% rule, the exchange will not be disqualified. However, the exchanger will only be able to acquire the properties that were identified, and will not be able to identify additional properties.
What Happens if You Can’t Close on 95% of Properties Identified Using the 95% Rule?
If the exchanger is unable to close on at least 95% of the value of the properties identified using the 95% rule, the exchange will be disqualified, and the taxpayer will be subject to capital gains taxes on the sale of the relinquished property. This means that the entire exchange will be treated as a taxable sale, and the exchanger will not be able to defer their capital gains taxes.
Remedies for Missed Deadlines
While missing a deadline in a 1031 exchange can have disastrous consequences, there are some remedies available to taxpayers.
File a Protective Return
If the exchanger misses the 45-day deadline, they can file a protective return with the IRS. This is a special type of tax return that allows the exchanger to report the exchange as if it were completed, even though the replacement properties have not yet been identified.
Request an Extension
In some cases, the exchanger may be able to request an extension of the 45-day or 180-day deadlines. This can be done by filing a request with the IRS, along with a payment of any required fees.
Consult with a Qualified Intermediary
A qualified intermediary is a professional who specializes in facilitating 1031 exchanges. As you work through the exchange, these specialists will be your Sherpas,mapping out the path ahead and mitigating any snags that might slow you down.
Conclusion
A 1031 exchange is a complex process that requires careful planning and strict adherence to the rules and deadlines set forth by the IRS. Miss these deadlines and you’ll face the fallout: a disqualified exchange and a nasty capital gains tax bill to boot. Capital gains taxes can be a major obstacle, but knowing the rules inside and out – and having a seasoned pro to guide you – can help you soar over that hurdle and secure a winning exchange.
We’re sharing this information to educate, not to provide customized tax or legal counsel – so be sure to consult a professional if you need specific guidance. Taxpayers should consult with a qualified tax professional or attorney to determine the best course of action for their specific situation.