Tax laws in the United States give real estate investors many benefits. Deferring the payment of capital gains tax is one example. The Internal Revenue Service (IRS) assists real estate investors with building wealth by allowing the deferred payment of capital tax gains through a 1031 exchange. In light of all the advantages of real estate investments, the IRS expects the 1031 exchange timelines to be diligently followed.
In a 1031 exchange, relinquished property sale proceeds may not be received if the transaction is to qualify as an exchange; therefore, any capital gains are taxable. However, with coordination among the buyer and other parties to the transaction, it may be possible to rescind the initial transaction and go forward with a 1031 exchange.
It is common for a qualified intermediary (QI) to receive questions from taxpayers who close the sale of their relinquished property, receive the sale proceeds, and then realize they should have differed substantial taxes in a 1031 exchange. Often, there may not be an opportunity to revive the exchange. However, there are cases when a taxpayer can rescind the transaction as long as it is in the same tax-reporting period and the buyer and taxpayer come to an agreement.
As long as the taxpayer receives the property back from the buyer and refunds the buyer the full purchase price on or before the end of the tax reporting period, the IRS will treat the sale as if it never happened.
Generally, costs that are incurred outside of escrow or the closing process should not be paid using 1031 exchange funds unless you are willing to pay tax on the amount spent. Pre-closing costs include all maintenance and fix costs that are incurred to prepare the property for sale. Additionally, you should not be reimbursed for such costs in escrow without being taxed. For these reasons, it is best to pay for any pre-closing costs out of pocket.
QI companies are not typically qualified or in a position to give legal advice regarding the 1031 exchange process or provide recession agreements. It is advisable to seek legal guidance from an experienced lawyer to ensure that your 1031 exchange process goes smoothly.
What Are the Benefits of a 1031 Exchange?
When selling an investment property and replacing it with another one, federal and state capital gain taxes are deferred. Recaptured depreciation taxes are also deferred. It is similar to having an interest free loan over an indefinite period. Additional capital can be used to generate more cash flow, diversify your portfolio, and boost your depreciation for tax strategies.
What Are 1031 Exchange Timelines?
When a 1031 exchange is conducted, there are two timelines that run at the same time:
- 45-day identification period: You have 45 days from the closing date on your relinquished property to identify one or more replacement properties. The replacement property need not be under contract on the 45th day. The QI facilitating the 1031 exchange provides a form used to finalize the identification period. If the form is not received by midnight on the 45th day of the identification period, the exchange automatically terminates, and the funds from the sale of the relinquished property are forwarded. This means capital gains tax will be due and payable that same tax year.
- 180-day exchange period: Escrow must be closed within 180 days from the closing date of the sale of the relinquished property. When a 1031 exchange starts in one tax year but may not be completed until after a new tax year begins, an extension for the federal income tax return needs to be filed in order to receive the full 180 days. If no extension is filed, the exchange will end on the original tax return due date.
Successfully conducting a 1031 exchange takes thorough planning. If you need to do a 1031 exchange after closing on your property, a knowledgeable lawyer can assist you with the process.
Ohio 1031 Exchange Services Lawyers at the Wolterman Law Office Can Advise You
Our Ohio 1031 exchange services lawyers at the Wolterman Law Office have vast experience and can help you facilitate your 10301 exchange. Call us at 513-488-1135 or contact us online to schedule a free consultation. We are located in Loveland, Ohio, and we proudly represent clients throughout Hamilton County, Fairfield, Norwood, and Forest Park.