Potential Pitfalls and Mistakes to Avoid in a 1031 Exchange

February 29, 2024
1031 National Services

Conducting a 1031 exchange offers the opportunity to achieve significant tax savings. But, mistakes along the way can prevent you from claiming the tax benefits available under Section 1031 of the Internal Revenue Code (IRC). There are several potential pitfalls, so it is crucial to work with an experienced 1031 exchange facilitator who can help you successfully navigate the process.

5 Critical Mistakes to Avoid When Conducting a 1031 Exchange

What are the pitfalls that can prevent you from securing indefinite tax deferral under Section 1031? Here are five critical mistakes to avoid when conducting a 1031 exchange:

1. Reinvesting Sale Proceeds in Non-Like-Kind Property

The first mistake to avoid is investing in non-like-kind property. Under Section 1031, tax deferral is only available when “real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment.”

While the definition of like-kind property is broad, not all exchanges qualify for tax deferral under Section 1031. As a result, one of the first steps in the process of conducting a 1031 exchange is making sure that you will be reinvesting the proceeds from the sale of your relinquished property into a like-kind property.

2. Missing the Deadline to Identify a Replacement Property

All 1031 exchanges are subject to strict deadlines. If you miss either of these deadlines, you can lose your eligibility for indefinite tax deferral under Section 1031.

The first deadline that you need to meet is the deadline to identify a replacement property. Under Section 1031, you have 45 days from the date that you sell your relinquished property to identify your replacement property. This requires formal identification through a qualified 1031 exchange facilitator—simply deciding on the property that you intend to purchase isn’t enough.

3. Missing the Closing Deadline

The second deadline that you need to meet when conducting a 1031 exchange is the deadline to close on the purchase of your replacement property. This closing deadline is 180 days from the date that you sell your relinquished property—not from the date that you identify your replacement property. So, if you take the full 45 days to identify your replacement property, you will only have 135 days to get to the closing table.

While this might sound like plenty of time (and, in many cases, it is), things can (and do) go wrong. As a result, when conducting a 1031 exchange, it is important to plan ahead as much as possible. For example, if you can identify a replacement property before selling your relinquished property, this will give you as much time as possible to resolve any issues that arise before your scheduled closing.

4. Conducting an Unintentional Partial 1031 Exchange

Conducting a partial 1031 exchange makes sense in some circumstances. For example, a partial 1031 exchange can be a good option for someone who wants to free up some cash or pay down some of their debt. But you do not want to conduct a partial 1031 exchange unintentionally.

There are a variety of ways this can happen. The first is simply not understanding the rules of a 1031 exchange. However, debt reductions, payment of certain expenses, and various other circumstances and events can also trigger the receipt of “boot” that is subject to non-deferred federal capital gains taxation.

5. Failing to Work with a Qualified 1031 Exchange Facilitator

Given the complexity of the 1031 exchange process and the potential challenges involved, it is best to work with a qualified 1031 exchange facilitator throughout the process. Trying to handle the process on your own can be daunting, and it can potentially lead to irreversible mistakes.

Additionally, while there are many companies and individuals that claim to offer 1031 exchange services, some are not as reputable as others. When choosing a 1031 exchange facilitator, it is important to choose carefully. Do your research, inquire about the facilitator’s experience and get referrals so that you can ensure that you are making an informed decision.

Discuss Your Transaction with a Qualified 1031 Exchange Facilitator for Free

Would you like to know more about how to successfully conduct a 1031 exchange? Are you looking for a qualified 1031 exchange facilitator who can guide you through the process? If so, we are available to help. To get started with a complimentary initial consultation at 1031 National Services, please call 888-872-1031 or tell us how we can reach you online today.