How Does A 1031 Exchange Affect The Seller?

How Does A 1031 Exchange Affect The Seller?

Posted by on Dec 15, 2020


Experts pay a great deal of attention to the taxpayer's actions required for completing a Section 1031 exchange. Less advice is available to the investor selling property as the replacement asset in that 1031 exchange transaction. However, the seller should be aware of some deadlines and potential “bumps in the road” as well.

The most common method of executing a 1031 transaction is a delayed exchange, in which the taxpayer sells the first property (referred to as the relinquished property) and then needs to identify the replacement property within 45 days and complete the purchase within 180 days (inclusive of the first 45). If the exchanger misses either deadline, the transaction becomes a sale rather than a 1031 exchange, and the taxpayer cannot defer recognition of the gain on the initial sale. It is worth noting that this is not as likely to be a stressor in a reverse exchange, in which the taxpayer has identified and acquired the replacement property before initiating the sale of the relinquished property.

There may be unusual execution risk for the seller of the replacement property due to the inflexible closing deadlines. If the property is identified near the end of the 45 days, the remaining allotment of time to obtain financing and close the sale is not generous. If the taxpayer does not complete the purchase in time for the deal to succeed as a 1031 exchange, it may not make sense for that person to consummate it as an ordinary property acquisition. Failure to meet this hard deadline could leave the owner of the replacement property with a failed contract.

As the seller of the replacement property, it will help move things along if you are aware of the deadline and cooperate with the qualified intermediary. The buyer of your property will have already placed the funds for purchasing the replacement asset into a separate account managed by an intermediary who will actively administer the purchase on their behalf. This step is necessary to defer the realization of the gain on the property. It would be best if you had language in the contract that acknowledges the following:

  •         As the seller, you are aware that the buyer is completing a 1031 exchange.
  •         You are willing to cooperate if you do not incur additional costs or assume other  liability.
  •         You are aware that the buyer has assigned specific rights to the qualified intermediary.

If the exchanger is performing a purchase that includes improvements to the property you are selling, the deadlines will be even more rigorous. If  the replacement property needs improvements to achieve parity with the value of the relinquished asset, those improvements are required for the property to be defined as "like-kind." In that case, not only does the sale have to be completed before the 180 days pass, but the improvements must also be finished.

The good news for you is that the buyer is strongly motivated to move the deal forward to consummation within the designated time. Unless there is a federal disaster declaration, the taxpayer is unlikely to receive any extension in the limits provided by the IRS for completing the exchange. 

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.


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