The short answer
Litigation does not disqualify a property from a 1031 exchange, but a recorded lis pendens puts every buyer and lender on notice of the claim, which usually stops a closing until the notice is removed or insured over. The exchange deadlines do not pause for a court calendar: only a federally declared disaster postpones them. Clear the notice before you sell, keep any disputed replacement off the top of your identification list, and treat money held back from your proceeds as cash that may come to you later as taxable boot.
At a glance
| Effect of a lis pendens | Later buyers and lenders take with constructive notice; the claimant's rights relate back to recording |
|---|---|
| Removal | Court-ordered expungement, or an undertaking that protects the claimant |
| Deadlines | 45 and 180 days run from the sale; litigation does not extend them |
| Only extension | Federally declared disasters, by up to 120 days, capped at one year |
| Holdback released to you | Cash received, taxable as boot to the extent of gain |
| Settlement paid from exchange funds | Not one of the closing items the safe harbor disregards |
| Identification | A disputed replacement belongs on the list only with a backup that can close without it |
A lis pendens does not stop the exchange, it stops the closing
A lis pendens, or notice of pendency of action, is recorded by a party whose lawsuit claims an interest in the land. California's statute is typical: under Code of Civil Procedure section 405.20 a party asserting a "real property claim" may record the notice, and under section 405.24 any later purchaser or lender takes with constructive notice and the claimant's rights "relate back to the date of the recording."
Nothing in section 1031 or its regulations treats litigation as disqualifying. The practical problem is that a buyer will not close, a lender may not fund and a title insurer may except the claim while the notice is of record. Check the rules in your own state with your attorney, because procedures differ.
The claim also matters for what you are selling. If the suit asserts an ownership interest, the buyer may be buying less than the whole property until it is resolved, and the amount the buyer will pay may change. Agree the price and what happens on each outcome in the contract before the exchange starts.
A lawsuit with no recorded notice, such as a contract or tenant claim, is a smaller problem: it may not cloud title at all, but the buyer may still ask for an indemnity or a holdback.
Clear the notice before you list, because the clock starts the day you sell
The 45-day and 180-day periods in Reg. section 1.1031(k)-1(b)(2) begin when you transfer the relinquished property. Time spent in litigation before the sale costs you nothing; a dispute that erupts after the sale eats the replacement window.
In California the court must expunge the notice if the pleading has no real property claim, or if the claimant cannot show its probable validity, under sections 405.31 and 405.32. Section 405.33 allows expungement conditioned on an undertaking where the claim has probable validity but money can protect the claimant, and section 405.34 lets the court require the claimant to post an undertaking to keep the notice on record.
If you are buying out a co-owner who is suing for partition, settle the ownership first; one partner wants cash and multi-owner exchange options cover the structures.
Holdbacks: money withheld from your proceeds is either boot or a cost, never exchange equity
When a buyer or title insurer will close only if part of the price is held in escrow until the suit ends, those dollars do not reach the qualified intermediary and cannot buy replacement property. If the escrow later releases them to you, that is money received and taxable to the extent of your gain under section 1031(b).
If the holdback is instead structured as part of the QI arrangement, its release terms must fit the limits in paragraph (g)(6), which allow access only after day 45 with no identification, after you receive all identified property, or on a written contingency beyond your control. Ask the QI before you agree to any holdback language.
Paying a settlement or a claimant's lawyer out of exchange funds is not one of the routine closing items that paragraph (g)(7) disregards, such as commissions, prorated taxes and title fees. Expect it to be treated as cash to you, and ask your CPA how the payment itself is treated.
Worked example: a $150,000 holdback on a $1,200,000 sale
Hypothetical, round numbers: you sell for $1,200,000 with no mortgage and a $500,000 adjusted basis. The title insurer requires $150,000 held in escrow until a boundary suit is resolved, so the QI receives $1,050,000.
If you buy $1,050,000 of replacement property, $150,000 of value is not replaced. When the suit settles and the $150,000 is released to you, $150,000 of the $700,000 gain is recognized, and the remaining $550,000 is deferred. Adding $150,000 of your own cash to buy $1,200,000 of replacement keeps the full value in the exchange, but the later release is still money received.
If part of the escrow goes to the claimant instead, ask your CPA whether that reduces your amount realized. Run your own numbers before you sign the escrow agreement.
The release usually comes in a later tax year than the sale. Ask your preparer whether the released amount is reported in the year of sale or the year received, and keep the escrow agreement and the court order with your exchange file.
A replacement under a lis pendens is a poor primary pick inside a 180-day window
If the property you want is under a notice of pending action, you inherit the claimant's rights from the recording date under section 405.24. You will also be closing against a deadline the court does not care about: section 17 of Rev. Proc. 2018-58 postpones exchange deadlines only for federally declared disasters, by 120 days or the disaster relief period, never beyond the return due date or one year.
Identify it only alongside properties that can close without it, and use the three-property rule to carry a backup. A DST interest is a backup with no title dispute to clear; our traditional DST page notes that clients often close within 3 to 5 business days. DSTs are illiquid and carry real estate risk. The day 45 to day 180 closing plan shows how to time it.
Related questions
Can I still do a 1031 if my property is involved in a lawsuit?
Yes. The tax rules do not care about litigation; title and closing do. Resolve or insure over any recorded notice before listing, because the exchange deadlines start when you sell.
Will the IRS extend my 180 days while a court decides the case?
No. The only postponement is for federally declared disasters under Rev. Proc. 2018-58. Litigation, lender delay and title problems do not qualify.
Is a litigation holdback taxable?
Money that is held back and later paid to you is cash received from the sale and taxable to the extent of gain. Whether amounts paid to the claimant reduce your gain is a question for your CPA.
Can the QI hold the disputed amount instead of the title company?
Possibly, but the QI's release terms are restricted by Reg. section 1.1031(k)-1(g)(6). Ask the QI and your attorney before closing, not after.
What if my identified replacement gets a lis pendens after I identify it?
You cannot add a new property after day 45, so you close on another identified property or try to clear the notice before day 180. See what to do when an identified property falls through.
Sources
Checked against these publications on September 30, 2026. Rules and figures change; confirm the current version with your CPA or attorney before you act. This page is general information, not tax or legal advice.
- California Code of Civil Procedure sections 405.20 to 405.24, notice of pendency of action
- California Code of Civil Procedure sections 405.31 to 405.34, expungement and undertakings
- Treas. Reg. section 1.1031(k)-1, Treatment of deferred exchanges
- 26 U.S.C. section 1031, Exchange of real property held for productive use or investment
- Rev. Proc. 2018-58, postponement of deadlines for federally declared disasters (section 17)
- IRS Publication 544, Sales and Other Dispositions of Assets