November 14, 2023 at 6:00 am
By: Dannielle Lewis, Teri Samples | Partners at Wipfli
1031 exchanges are common in the real estate world. However, they are often wrought with hidden complexity that can quickly send a straightforward project into chaos.
Here are four common mistakes to avoid when planning and executing your 1031 exchange:
1. Comingling personal property
Prior to the Tax Cuts and Jobs Act (TCJA), taxpayers were allowed to do 1031 exchanges on both personal and real property. However, personal property can no longer be part of a tax-deferred exchange post TCJA.
Initially, this led to complicated questions regarding how real property is defined. Much of this was answered by regulations that became final in 2020.
The regulations are fairly taxpayer friendly but are not without their own complexities. Many still comingle their 1031 exchanges with personal property and end up recognizing gain as a result. In the worst scenarios, this can ruin the exchange.
If you are selling any real property that has personal property in it, connect with your certified public accountant (CPA). They can help you determine the best way to break out personal property from the rest of the property so that it doesn’t affect your exchange.
2. Missing the 1031 timeline
Missing the prescribed timelines is another commonly seen mistake in 1031 exchanges.
A 1031 exchange must generally adhere to the following timeline from the date of the sale of the relinquished property:
- 45 days to identify a property
- 180 days to complete the exchange
The best advice is to know your replacement property prior to selling the relinquished property.
Since this can be challenging, people often try to close deals too quickly. They miss the important step of identifying the properties in time, or they schedule the closing too late.
3. Confusing different roles
For some 1031 exchanges, tax issues aren’t discovered until the return is being completed.
The taxpayer may be relying on their qualified intermediary (QI) to identify any issues with the 1031 exchange itself. However, that is not necessarily their role.
It is important to understand what advice your QI is giving you and what their role is in the exchange. While they may have all the information that pertains to your exchange, they generally never provide any tax advice. To ensure you have a valid 1031 prior to closing, you need to meet with your CPA. Finding out a tax issue too late can make it unfixable.
On the other hand, if errors are discovered early on, you can either restructure the deal or even invest your gain dollar in an opportunity zone fund instead.
4. Overlooking partnerships
Another common mistake to avoid is with partnerships.
Often, issues with partnerships involve two partners who want to roll proceeds from a property that has been held for several years into another property, while the third partner wants to cash out.
Depending on when this situation comes up, it could create a lot of issues for the exchange, especially when an alternative structure is rushed too close to closing.
It’s important to look at your real estate holdings and ownership each year to determine if your partnership is still on good terms or if you think one of the partners will want to exit.
Planning allows for more time to work through an ownership structure that will facilitate a 1031 exchange, while ensuring each partner is able to achieve their end goal.
How Wipfli can help
At Wipfli, our team is here to help you navigate the complex regulations surrounding 1031 exchanges. We’ll help you understand your eligibility and tax consequences so that you can plan with confidence.
Contact us today to get started with your exchange.
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Original article posted on January 17, 2023: https://www.wipfli.com/insights/articles/re-4-mistakes-to-avoid-in-the-1031-exchange-process