Tax Straddling: The Surprise Advantage of a Year-End 1031 Exchange

Halloween may be over, but a treat might exist for those taxpayers who initiate a 1031 tax-deferred exchange on their second home residential property investment (or rental investment, or commercial/investment property) toward the end of 2016, only to find that their exchange fails in 2017 or they receive any amount of cash boot in 2017.

The good news is the IRS provides the treat in that there might be a back-up benefit in store – 1031 tax straddling – which provides added incentive to most taxpayers selling investment property at the end of the year who face the above mentioned circumstances.

Here is how it works. In a tax deferred exchange, taxpayers typically have 45 days from the sale of the old property to identify potential replacement property and 180 days to complete the purchase of the identified property. Once a 1031 Exchange is initiated, if replacement property is not purchased 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, in some cases, the 181st day (the day when the 1031 Exchange time period is complete).

Taxpayers who enter into a 1031 Exchange during the fourth quarter of 2016 and receive their funds back from the Qualified Intermediary in 2017, have the option of deferring payment of taxes on the profits from their sale until 2018 – the due date of their 2017 tax return. Combining §1031 with §453 permits the cash received from the Qualified Intermediary at end of the exchange to be treated as a payment in the year of actual receipt, rather than in the year the property was sold.

The best part? The IRS does not penalize investors for attempting to complete a 1031 Exchange. Tax straddling merely provides added incentive to taxpayers selling investment property at the end of the year. So why not attempt to complete a 1031 Exchange when a one year deferral is available as the back-up plan?

PLEASE KEEP IN MIND THIS IS NOT ACCOUNTING NOR LEGAL ADVICE and I AM NOT AN ACCOUNTANT.

Consult with your tax advisor since tax straddling does not apply to all sales, and any gain attributed to debt relief will still have to be recognized in the year of sale.