Often times, a 1031 qualified intermediary (QI) will receive a panicked phone call from a taxpayer who closed the sale of their relinquished property, received the sale proceeds and then realized they could have deferred substantial taxes in a Section 1031 exchange. In many of these instances there may not be an opportunity to revive the exchange, however, in some cases, the taxpayer may be able to breathe new life into what was thought to be a lost cause.
Can you do a 1031 exchange after closing?
The use of rescission has long been recognized in law generally in connection with transactions not related to 1031 exchanges. However, the Internal Revenue Service (“IRS”) has allowed the use of rescission to correct a problem with an exchange transaction. “Rescission” is not defined in the
Internal Revenue Code (IRC). The comprehensive set of tax laws created by the Internal Revenue Service (IRS). This code was enacted as Title 26 of the United States Code by Congress, and is sometimes also referred to as the Internal Revenue Title. The code is organized according to topic, and covers all relevant rules pertaining to income, gift, estate, sales, payroll and excise taxes.
Internal Revenue Code
Internal Revenue Code
or the Treasury Regulations, which are the source of most rules used to advise taxpayers. Rather, rescission is a concept which some courts have allowed, and the IRS has blessed, specifically in Revenue Ruling 80-58, 1980-1 C.B. 1156. The IRS has also issued private letter rulings in the past for taxpayers in specific fact patterns. There is other general authority for rescission in the case of Penn v. Robertson, 115 F2d 167, 40-2 U.S. Tax Cas. (CCH) P. 9707 (CCA 4th Cir. 1940).
As an example, consider an individual taxpayer closes the sale of a parcel of land in February 2020 for a sizable gain. The taxpayer receives the sale proceeds but later finds out they could have deferred substantial tax liability by doing a 1031 exchange. As long as the taxpayer makes the decision to rescind the transaction in the same tax-reporting period–in this example before 2020 year-end–the taxpayer can contact the buyer and they can agree to rescind the transaction. Of course, should the buyer not be willing to cooperate, or should there be a buyer’s lender who does not wish to participate, this process may not be feasible.
Seller and buyer agree to rescind. What happens next?
When a rescission is properly completed, the IRS treats the sale as if it never happened, as long as the taxpayer receives the property back from the buyer and the buyer receives the full purchase price back from the taxpayer on or before the end of the tax reporting period for the taxpayer. The parties may agree they were laboring under mutual mistake of fact or some other reason for the decision to rescind. Another important consideration is when the rescission of the transaction is complete, the parties should have no further obligations to each other to take any further action. If these criteria are met, pursuant to the authorities cited above, the parties are in the exact position they were prior to the sale. The taxpayer and the buyer can then undertake another sale and purchase transaction and close the transaction with the participation of a QI company, like Accruit, receiving the exchange proceeds so it can help process the taxpayer’s 1031 exchange. In order to ease the burden on the buyer during rescission, it may be helpful if the taxpayer agrees to pay for any buyer expenses incurred in accommodating the taxpayer.
Typically, the QI company is not in a position to provide legal advice regarding the rescission process or provide any rescission agreement. There are numerous attorneys and CPA’s nationwide who are knowledgeable in this area of the law and who can help advise the taxpayer.
Do you have an uncommon situation that you have questions about? Ask our experts.