Many investors rely on 26 U.S. Code § 1031 – “Exchange of Real Property Held for Productive Use or Investment” to potentially defer capital gains and depreciation recapture taxes triggered by the sale of real estate.
There are four types of like-kind exchanges:
- Delayed exchange
- Reverse exchange
- Improvement/construction exchange
- Simultaneous exchange
These exchanges have deadlines and timelines that must be followed to take advantage of potential tax deferrals. Let’s examine the time limits associated with the delayed exchange.
A Brief Review
Sometimes known as the “deferred exchange,” a “delayed” 1031 exchange could also be considered “the most common exchange.” It tends to be used more often than other types.
You sell your original asset (your relinquished property) through the delayed exchange. The sale proceeds go to your Qualified Intermediary, where they remain until you buy and close on your replacement property. At that time, the QI will funnel those proceeds into that purchase.
While the delayed exchange is pretty straightforward, it also comes with in-stone timelines mandated by the IRS. Failure to meet those deadlines could mean an unsuccessful exchange. And an unsuccessful exchange could mean an unexpected tax bill.
The Time Limits
Here’s what needs to go on your calendar when participating in a delayed 1031 exchange.
The 45-Day Limit
You have 45 days from the date of your relinquished property’s/properties’ closing to identify a replacement property or properties. But this period requires more than simply pointing a figure at a likely property and saying, “That’s the one I want.”
Other required activities during this time period include:
- Reporting the potential acquisition to your QI
- Ensuring that the replacement asset or assets are of equal or greater value than your relinquished property
- Adding a specific clause to the purchase contract for both the relinquished and replacement properties indicating they’re part of your like-kind exchange
Once the calendar page turns to day 46 after the relinquished property’s closing, you can’t add any more replacement properties.
The 180-Day Limit
Once the 45-day time limit is reached, you have just 135 days to acquire your replacement property or properties. Specifically, you must close on the replacement choice within 180 days of selling your replacement property or properties.
This means you have less than six months to perform any due diligence or research on the replacement property.
This is in stone – if the 180th day falls on a Saturday or a holiday, it doesn’t matter. You must still close on that day to take advantage of any potential tax deferrals. Closing on day 181 means your exchange is considered void.
Filing Form 8824
Finally, you need to file paperwork with the IRS detailing the exchange. You’ll fill out Form 8824 – “Like-Kind Exchanges” with your tax return in the year following the exchange. You’ll fill out one form per exchange.
The delayed like-kind exchange can provide tax-deferral benefits. But those benefits can go away if you fail to meet the time limits and deadlines indicated by the IRS. If you plan on using a delayed 1031 exchange, keep an eye on the calendar. It’s also an excellent idea to consult an expert.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Costs associated with a 1031 transaction may impact investor's returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.