Tuesday, December 13, 2011

Failed Exchanges – Safe Harbor and Options

We found information regarding 1031 exchanges and tax obligations on an exchange between two calendar years. Typically we have found that the Internal Revenue Service ("IRS") will not challenge or disqualify a 1031 Exchange transaction as long as the investor has followed the Safe Harbor provisions or guidelines provided by the Treasury Regulations. What this means is to use a qualified 1031 intermediary who will hold the sales proceeds until a like kind property is located, so the sale proceeds never actually reached your account. If you do a 1031 by yourself and receive the funds from the sold property then you still may have an option on when to account for the taxes.

If an exchange fails, funds are returned to the investor and taxes are owed. But if a failed exchange runs over two different calendar years, investors may have an option on when to pay taxes. Let’s say the sold property closes escrow on December 1, 2011 and as of the 45th day of the exchange, the investor has not found a replacement property so the the exchange is now cancelled. The sale proceeds from the sold property must then be returned to the investor in January 2012 whic is the 46th day of the exchange. The investor has the option to recognize the tax liability either in 2011 or 2012. The investor sold the property in 2011, but they had the right to the benefit in 2012. The investor should contact their accountant for the best option, but this scenario does provide such an option.

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