1031 Exchanges and Year-End Tax Planning
Failed or Partial 1031 Exchanges and the Timing of the Receipt of Funds
When should you receive your funds from a failed 1031 exchange transaction, or the remaining funds in your 1031 exchange account after you have acquired all of your replacement property? Many Exchangors do not realize that a failed or partial 1031 exchange can provide some great year-end tax planning opportunities.
Example of Failed 1031 Exchange:
You sold your relinquished property on November 1, 2003. Diversified Exchange Corporation is holding your 1031 exchange proceeds as part of a forward 1031 exchange. The 45-calendar day deadline to identify your replacement property passes and you now find yourself with only a few days left before 2004 rolls around. Because your 45-calendar day identification period has expired and you did not identify any replacement property, Diversified Exchange Corporation can release your failed 1031 exchange funds to you at your direction. When should you request the funds?
Gain Recognition
In the case of a failed or partial 1031 tax-deferred, like-kind exchange transaction, an Exchangor will recognize the gain in the year the cash is received rather than the year the relinquished property was transferred. An Exchangor who commences their 1031 tax-deferred, like-kind exchange transaction in 2003 and receives the cash from the failed or partial 1031 exchange in 2004 will report the gain on their 2004 Federal income tax return pursuant to Section 453 of the Internal Revenue Code.
The Exchangor should meet with his or her professional tax advisor to determine the most beneficial year in which to recognize the gain and then instruct the Qualified Intermediary to release the 1031 exchange funds accordingly. To be eligible, an Exchangor must enter into a 1031 tax-deferred, like-kind exchange with a Qualified Intermediary, such as Diversified Exchange Corporation, and must have a bona-fide intent to complete the 1031 tax-deferred, like-kind exchange.
This short-term tax deferral strategy provides an excellent tax planning opportunity when your 1031 tax-deferred, like-kind exchange transaction fails unexpectedly. The Qualified Intermediary cannot distribute your 1031 exchange funds if the disbursement would violate any early release provisions of the Like Kind Exchange Agreement and/or Treasury Regulations.
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