Year-end Tax Planning with Section 1031

If you are selling property before the end of the calendar year, you have a potential opportunity to plan for taxes in 2010 by utilizing Internal Revenue Code section 1031 as a tool. Whether a 1031 exchange is ultimately completed or not, there may be an opportunity to choose whether the tax will be paid in 2009 or 2010. This is because, under exchange rules, your right to receive the proceeds from the sale of the property are held by a third party Qualified Intermediary. If you are unable to identify or close on a sale, and subsequently, the exchange fails, your first right to the proceeds doesn't occur until 2010. How is that? It has to do with the time of year we have entered.

Under 1031 exchange rules, a person exchanging property may receive the sale proceeds (a) after the expiration of the 45 day identification period (if the taxpayer did not identify any replacement property); or, (b) the date upon which the taxpayer acquires all replacement property identified by the taxpayer in the exchange, or (c) at the end of the 180 day exchange period. So if you sell a property on December 15th, your 45 day period would not occur until January 29th.

Section 1031 says that if your exchange fails in a different tax year than the year you sold it, the IRS's installment sale rules kick in. So, the taxes that would be due in 2009 could be deferred until 2010. I say COULD be because the installment sale rules also allow you to elect out of them.

If the Obama administration and Congress decide to raise capital gains rates before the Bush tax cut is set to expire at the end of 2010, a taxpayer whose exchange failed could elect out of the installment reporting rules. This also might help if you determine, before filing your tax return, that it would be better to go ahead and recognize the gain in 2009. This stategy, setting up an exchange now, would allow you to plan and recognize the gain in the year of greater tax benefit for you.

Of course, you should have a legitimate intent to complete an exchange and not simply look at this as a tax deferral strategy. However, if you are selling real estate and MIGHT reinvest the proceeds in replacement property, it could certainly make sense to setting up an exchange - just in case. If you are considering this option, you should also consult with your tax accountant or attorney regarding your specific tax situation. For more information on this option, visit our 1031 exchange professionals website or give us a call at 888-367-1031.