updated October 2020
Be sure to read Tax Straddling – Pay Taxes in 2021 or 2022?
Trick or treat time? A treat might exist for those taxpayers who initiate a 1031 tax-deferred exchange towards the end of 2015 only to find that their exchange fails in 2016 or they receive any amount of cash boot in 2016. 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 abovementioned circumstances.
If a taxpayer successfully completes a 1031 Exchange, the main benefit is tax deferral. If a taxpayer is not able to purchase new property to successfully complete the 1031 Exchange, the taxes associated with the sale of their investment property will be due. With “tax straddling” the taxpayer may still receive a one year tax deferral thanks to installment sale rules (§453 / Publication 537). 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? 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 purchase 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 2015 and receive their funds back from the Qualified Intermediary in 2016, have the option of deferring payment of taxes on the profits from their sale until 2017 – the due date of their 2016 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 IRS does not penalize investors for attempting to complete a 1031 Exchange. Tax straddling just provides 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 deferral is available as the back-up plan?
Taxpayers should consult with their tax advisors 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. Please call us at IPX1031® to discuss tax straddling and other valuable tax-deferral solutions, such as structured sale treatment, 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.
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