In short
Seven facts that surface on first calls after they have already cost something: a closed sale, unreplaced debt, buyer credits, a missed deadline.
Most of the damage in a 1031 exchange is done before anyone calls an exchange broker. The same seven sentences come up on first calls, and each one is a rule that was applied too late. None of these are client stories; they are patterns, each tied to the regulation that makes it expensive. The one exception is the last item, which comes from a case study we publish.
Four that end or shrink the exchange
1. “We already closed, the money is in our account.”
This one ends the exchange. The deferred exchange safe harbor in Reg. section 1.1031(k)-1(g) works only if the exchange agreement provides that you have no rights “to receive, pledge, borrow, or otherwise obtain the benefits of money or other property before the end of the exchange period.” Once the proceeds reach you, there is no exchange period. The time to call is before the purchase contract is signed, or at the latest before closing; see is it too late to start a 1031.
2. “Our CPA is going to hold the funds for us.”
Your CPA cannot. Paragraph (k)(2) of the same regulation makes a disqualified person of anyone who “has acted as the taxpayer’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the 2-year period ending on the date of the transfer.” A disqualified person cannot be the intermediary, and funds held by one are treated as received by you. The intermediary must be independent; what one needs from you is in what the intermediary needs to open an exchange.
3. “We paid off the mortgage at closing, so debt is not an issue.”
It is the issue. Under Reg. section 1.1031(d)-2, liabilities assumed by the other party, or liabilities to which the exchanged property is subject, are “treated as money received by the taxpayer upon the exchange.” The relief is offset by new debt you take on or cash you pay, but it does not disappear because the bank was paid from escrow. The arithmetic is in debt replacement in plain words; the structure that covers a large debt figure with a small slice of proceeds is a cash out DST.
4. “The buyer took a credit for the deposits and the roof.”
Credits shrink what reaches the intermediary without shrinking what you have to reinvest. Reg. section 1.1031(k)-1(g)(7) disregards prorated rents and the usual transactional items such as commissions, prorated taxes, transfer taxes and title fees, but a credit that settles your own obligation, tenant deposits you hold or a repair you agreed to pay for, is not a cost of transferring the property. The fix is to move those items off the settlement statement and pay them from your own account, as explained in security deposits and rent prorations as boot.
Three about deadlines and use
5. “Day 45 was last week, but we have a handshake on a building.”
A handshake is not an identification. Replacement property must be identified in a written document signed by you and delivered before the end of the 45-day period, and it is limited to three properties of any value or any number up to 200 percent of the relinquished value, with the 95 percent rule as the fallback. After day 45 the list cannot be changed; see changing identification after day 45. The callers who avoid this problem identified a DST as a backup alongside the building, which is the logic in our backup DST strategy.
6. “We missed day 180.”
The exchange period ends at midnight on the 180th day after the transfer, or on the due date of your return if earlier, and the gain is recognized. What remains is to decide what to do with the tax. One of our published case studies describes a client who failed to close within the 180 days on about $1,200,000 of proceeds, facing roughly $400,000 of tax, and instead invested about $500,000 across two bonus depreciation funds in the gas station and convenience store asset class, generating enough depreciation that year to offset the gain. That is a strategy for a specific set of facts, not a promise; the options after a failed exchange are set out in failed 1031 exchange options, and depreciation taken now is recaptured later.
7. “My daughter is moving into the replacement.”
Section 1031(a)(1) covers real property “held for productive use in a trade or business or for investment” and exchanged for real property “to be held either for productive use in a trade or business or for investment” (26 U.S.C. section 1031). A replacement bought for a child to live in rent-free was not acquired to be held for investment. Renting to family at market rent is a different question with its own rules, covered in renting the replacement to a child, parent or your own business, and moving in yourself later is covered in moving into a 1031 replacement.
Why the timing of the call matters more than anything in it
Every item above is cheap to fix a month before closing and impossible to fix a day after. Step 1 of our process is a conversation about your goals, tax exposure and investment preferences; the earlier it happens, the more of the seven are still open. A hypothetical to make the point: a $1,000,000 sale with a $300,000 loan, $30,000 of credits to the buyer and no intermediary engaged has, after closing, zero deferral available. The same sale with an intermediary assigned into the contract, the credits paid outside escrow and $300,000 of replacement debt or cash arranged defers the whole gain. Run your own numbers with your CPA.
What to do now
- Call before the contract is signed, not after the closing is scheduled.
- Send the draft settlement statement to your intermediary and CPA a week before closing and have every credit line marked.
- Identify a backup DST in writing inside the 45 days, even if you expect the building to close.
- Request a proposal with your closing date and loan payoff in hand.
