updated October 2020
Be sure to read Tax Straddling – Pay Taxes in 2021 or 2022?
If a taxpayer successfully completes a 1031 Exchange, major benefits include deferral of taxes and the ability to invest all of their equity. However, if a taxpayer is not able to purchase new property to successfully complete the 1031 Exchange, and the exchange fails, the taxes associated with the sale of their investment property will be due. Tax straddling may help with their immediate tax burden.
With “tax straddling” the taxpayer may receive a one year tax payment deferral thanks to the coordination between IRC §453 and §1031 provided in the §1031 regulations. Assuming a qualified intent, tax straddling provides added incentive to taxpayers to sell their relinquished properties near year-end to take advantage of the significant tax-deferral benefits of 1031 Exchanges with the one-year deferral benefits of §453 as a back-up plan.
How does this work? If a delayed 1031 exchange begins in the latter portion of 2016, the exchange period may run into 2017. If the exchange fails or if the taxpayer (having a bona fide intent to do an exchange) receives cash boot in 2017, the 1031 regulations treat the exchange as an installment sale allowing the taxpayer to consider that the exchange proceeds were received (and are taxable) in 2017. However, in accordance with IRC section 453(d), a taxpayer may “elect out” of the installment method. By electing out, the taxpayer can recognize the gain in 2016 instead of 2017.
To elect out, the sale should be reported on Form 8949, Form 4797 (or both) and not on Form 6252. The election must be made by the due date, including extensions, for filing the 2016 tax return. For more information about the procedure and forms to use, see IRS Publication 537 and consult with your tax advisor, since tax straddling does not apply to all sales and any gain attributed to debt relief will have to be recognized in the year of sale.
The IRS does not penalize investors for attempting to complete a 1031 Exchange. Tax straddling provides an added incentive to taxpayers selling investment property at the end of the year. Why not attempt to complete a 1031 Exchange when a one year payment deferral is available as the back-up plan?
Please call us at IPX1031 to discuss tax straddling and other valuable tax-deferral solutions which can provide taxpayers unable to successfully complete exchanges with generous tax-deferral safety nets. Be sure to consult with your tax advisor to determine if you can take advantage of these valuable tax-deferral methods.