1031 Exchange Q and A: When Is It Too Late?

Peter and Wendy sold an apartment complex last month for $6,000,000.

Peter complained to his friend James that because his adjusted basis in the property was $3,200,000, he will have to report a capital gain of about $2,800,000 from the sale of the apartment complex on this year’s tax returns, and will have to pay $420,000 to the IRS in capital gain taxes on his profit from the sale.

James tells Peter that he should do a Section 1031 exchange on the property, so that he can legally avoid paying the capital gains tax.

James also tells Peter that he can report the sale as an exchange, even though the sale has already taken place, because he was planning to purchase another investment property this year with his profits, and he had not yet filed his tax returns.

Can Peter use Section 1031 to legally avoid paying capital gains taxes on the sale of the apartment complex?

The answer is No.

Unfortunately, Peter cannot retroactively turn a taxable sale into a tax-free exchange under Section 1031.

The transaction must be structured as a Section 1031 exchange before either end of the transaction (that is, the sale of the relinquished property or the purchase of the replacement property) has taken place.

Remember, if you receive any of the proceeds from the transaction (either by actual or constructive receipt) before the entire exchange is completed, the transaction is a taxable sale.

To contact Melissa J. Fox about serving as a qualified intermediary or for other 1031 exchange services, send an email to strategicfox@gmail.com

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