Real estate investors who undertake 1031 exchanges in order to defer capital gains tax liabilities or diversify their real property holdings have six months from the closing date on their relinquished properties to complete their exchanges.
That 180-day timeline to wrap up the exchange may span two calendar years – any exchange undertaken roughly after early July 2023 could theoretically bleed over into 2024. Additionally, any exchange launched late in the year, say November or December, likely wouldn’t be completed by the April tax deadline, which raises additional concerns for the taxpayer.
There are a number of considerations to take into account for 1031 exchanges that straddle consecutive calendar years. Let’s jump in and discuss.
Considerations for 1031 Exchanges that Span Consecutive Years
In order to receive full deferral of any realized gain on the sale of an investment property, you’ll have to complete the entire exchange process within 180 days. That includes formally identifying a replacement property within 45 days of closing on your relinquished property and closing on the replacement asset within that six-month window.
Here’s where things can get a bit dicey for late-year exchanges, though. According to Internal Revenue Code Section 1031, the exchange period actually ends on the earlier of:
- 180 days after close of sale on the relinquished property
- The due date of the taxpayer’s return for the calendar year in which the asset was sold
If you divest your original asset in late December of 2023, you won’t get the full 180 days before the April 15, 2024 tax deadline. In order to utilize the full exchange period in this scenario, you’ll have to file an extension for their tax return. This is very important: If you haven’t closed on your replacement asset by the tax deadline, and you don’t file an extension, your exchange may be treated as a straight sale and you will be subject to capital gains and depreciation recapture taxes on the sale of your relinquished property.
Here’s another scenario in which an exchange can span multiple years. In a 1031 exchange installment sale, the seller of the relinquished property agrees to receive payment for the asset over a set time frame that can span multiple calendar and tax years. This method could be attractive to certain buyers and sellers because it allows more flexibility on the buyer side – the purchaser doesn’t have to come up with all the money needed to acquire your property all at once.
If you do carry back an installment note, you’ll have to choose whether to include any tax consequences generated from installment payments as part of an installment sale, a structured sale, or part of the 1031 exchange. Each method creates different tax consequences, so it’s important to map out a game plan well in advance of initiating your 1031 exchange.
Putting it all Together
Oftentimes, 1031 exchanges will span multiple years. There’s no stipulation that an exchange must be completed within the same calendar year. However, exchanges that straddle multiple years can bring about unique timeline and tax consequences. Be sure to consult with professionals well-versed in 1031 exchange laws and taxation rules to help ensure your exchange remains compliant with stringent IRS regulations.
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.