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1031 Exchange Tax Straddling for 2023

Dave Tornell
10/06/23
If you start a 1031 Exchange after July 5th with one or more replacement properties identified or November 17th without any identification, both of those situations will cause the exchange to span across two tax years per IRS rules. In the case of the 17th, the 45 day identification period would not be up until the following year. And in the case of the 5th, the 180 day exchange period will similarly not be up until the following year. So based upon these dates, even for a failed exchange, due to the “tax straddle”, a taxpayer who had a bona fide intent to do an exchange can get deferral until the tax return for the second year is due, learn more in this article.
1031 Exchange Tax Straddling Two Tax Years for 2023

October is now in full force with cooler temperatures, fall colors, pumpkins, and scary haunted houses. However, being scared is not necessary for those investors hesitant about initiating a 1031 Exchange prior to year-end because they fear that they won’t find new property to successfully complete their tax deferred exchange. The good news is that there might be a back-up option in-store, referred to as 1031 tax straddling, which provides tax deferral reassurance to most taxpayers selling investment property at the end of the year.

If a taxpayer successfully completes a 1031 Exchange , the main benefit is tax deferral of Federal Capital Gains, Depreciation Recapture, State, and Net Investment Income Tax (if applicable). However, if a taxpayer is not able to purchase new property to successfully complete the 1031 Exchange , the above taxes associated with the sale of their investment property will be due. With “tax straddling” the taxpayer may still receive a one-year tax deferral of the Capital Gains tax, thanks to IRS Installment Sale rules (§453/Publication 537). Assuming a bona fide intent to exchange, tax straddling provides an additional option to taxpayers who choose to sell their Relinquished Property near year-end to take advantage of the significant tax-deferral Capital Gain benefits of 1031 Exchange s. The one-year deferral benefits of Section 453 is a bit of a silver lining should they be unable to complete a successful 1031 Exchange .

Tax Straddling for a Failed 1031 Exchange In a 1031 Exchange , taxpayers have 45 days from the sale of the old property, the Relinquished Property, to identify potential Replacement Property and then a total of 180 days, to purchase the identified property(ies). Once a 1031 Exchange is initiated, if Replacement Property is not identified within 45 days, or purchased within 180 days to complete the exchange, the earliest the Qualified Intermediary can return the taxpayer’s funds is on the 46th day (the day after the identification time period has ended) or, if Replacement Property was identified, the 181st day, the day after the 1031 Exchange time period is complete.

Taxpayers who enter into a 1031 Exchange that ultimately fails due to either failure to identify Replacement Property within the 45-day period or failure to acquire Replacement Property within the 180-day, exchange will have their funds to be returned back from the Qualified Intermediary in 2024 creating a taxable event. The default reporting in such cases is deferring payment of Capital Gains tax from their Relinquished Property sale until 2025 - the due date of their 2024 tax return. Combining §1031 with §453 permits the returned exchange funds received back from the Qualified Intermediary at end of the failed exchange to be treated as a payment in the year of actual receipt, rather than in the year the property was sold.

The IRS does not penalize investors for attempting to complete a 1031 Exchange . Tax straddling just provides an additional option to taxpayers selling investment property at the end of the year.

For more information, this article provides a more detailed explanation of Installment Sales in relation to a 1031 Exchange.

Taxpayer s should consult with their tax advisors since tax straddling per Installment Sales Rules does not apply to all sales, and any gain attributed to debt relief will still have to be recognized in the year of sale. Be sure to consult with your tax advisor to determine if you can take advantage of these valuable tax-deferral methods.

 

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified  Intermediary , and as such does not offer or sell investments or provide investment, legal, or tax advice.