Consider this scenario: You hear the market is hot, and you decide to swap out a property you own for a new one. Possibly to create more revenue, perhaps because it’s closer to you geographically, or because you want less maintenance to perform. In any of these situations, you have a limited time to act once you sell the property you are exiting, and it is not always easier to close on a new property. Read the following to learn about the specifics of the 1031 Exchange time limits.
A 1031 Exchange is a swap of one real estate investment property for another one that results in a deferral in capital gains taxes when certain requirements are met.
If you would like general information about the tax benefits in California of a 1031 Exchange, please see our earlier blog post on the question of whether a 1031 Exchange Avoids California Taxes.
As you might expect, the swap is triggered when you sell the real estate position that you are closing out of, called the relinquished property. It is unlikely that you are selling your property to the owner of the property that you are buying, though that is allowed and decreases the time pressure. In that situation, the selling and buying are simultaneous. It is much more likely that you are selling to a second party and buying from a third party. The law allows such a three-party deferred exchange.
It is sometimes referred to as a Starker exchange after the 1970s appellate court case that allowed a party in Oregon to use a delayed exchange. The triggering event is the sale of the relinquished property.
There are steps that must be set up before the sale, including the legal vehicle to hold the funds from the sale until used for the qualifying real estate purchase. This includes the use of a middleman (a qualified intermediary or another exchange facilitator) to maintain the funds until the replacement property is paid for. And all of these things fall within the 1031 Exchange time limits.
The First Deadline: 45-Day Identification Period
After you sell the relinquished property, you have 45 days to designate your replacement property. This designation must be signed by the taxpayer and in writing to the qualified intermediary or escrow agent. You cannot satisfy this requirement solely by notifying your attorney, real estate agent or accountant.
The identification begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day after that. If you fail to identify your replacement property before the end of the identification period, the IRS will not treat the property as a “like-kind” to the relinquished property.
Under the 3-property rule, you can identify three properties without regard to their fair market value. Under the 200-percent rule, you can identify any number of properties as long as their aggregate fair market value, as at the end of the identification period, does not exceed 200 percent of the aggregate fair market value of all the relinquished properties as of the date the relinquished properties were transferred by the taxpayer.
The Second Deadline: 180-Day Exchange Period
After you sell the relinquished property, you have at most 180 days to purchase your replacement property. The exchange period that you must comply with begins on the date the taxpayer transfers the relinquished property and ends at midnight on the earlier of the 180th day thereafter or the due date (including extensions) for the taxpayer’s return of the tax imposed by chapter 1 of subtitle A of the Code for the taxable year in which the transfer of the relinquished property occurs. If you are relinquishing multiple properties, the rule is different, and our lawyers can assist in calculating the relevant period. Both deadlines are absolute and cannot be altered.
A Safer Option: The Reverse Exchange
If you are concerned about your ability to find and close on an eligible replacement property, you can purchase the replacement property before you sell the property that you wish to relinquish. Of course, you must still be able to relinquish the property and provide qualified funds within the timeline mentioned above.
This can be accomplished by setting up a single-member LLC composed of the intermediary. As the taxpayer, you would enter into a contract that provides for the LLC to hold the property until the sale of the relinquished property is closed. At that point, the relinquished property is exchanged for the replacement property in a forward “exchange.”
Possible Tailwind Scenario for Buyers
If you are in a hurry to buy, things are turning in your direction. The market for buying real estate in California has been changing recently. Demand has been cooling and sales numbers have trended down, dropping 21% in June 2022, compared to June 2021, as the California Association of Realtors reported. This does not mean it is a buyers’ market, as the median time on the market was still only 11 days, and many homes are still selling above the listing price.
Pending sales have dropped towards the lows experienced at the beginning of the pandemic, particularly in the upper-price segments. This has resulted in increased supply. The state’s median home price declined four percent in June to $863,790 from the revised May record-high of $900,170, although that is still five percent higher than the $819,630 recorded last June, the Association reports.
Stay on Track and on Time, with our Advice
There are many instances when not meeting a deadline can be costly, and this is one of them. Our lawyers and staff are familiar with the laws that impact your taxes, finances, and estate planning instruments. We have counseled innumerable clients on these and other essential matters, and can help you meet your 1031 Exchange time limit. We are happy to assist by answering your questions, providing legal advice, examining your current estate plan, and getting involved to help advance you towards your goals.
Call the trusted attorneys at Lowthorp, Richards, McMillan, Miller & Templeman at (805) 981-8555 or fill out our online contact form. We operate primarily in the Tri-Counties area – Ventura, Santa Barbara, and San Luis Obispo.