5 Mistakes to Avoid When Executing a 1031 Exchange

iQuanti: A 1031 exchange is a complicated real estate transaction with tight deadlines and strict legal requirements. But for real estate investors, there can be benefits from the tax-deferral of capital gains as they sell one rental property and purchase another. To ensure a like-kind exchange transaction remains in a tax-favored status, investors will need to avoid these five mistakes.

#1 Naming an Ineligible Person as a Qualified Intermediary 

A qualified intermediary (QI) is responsible for facilitating the 1031 transaction. However, IRS guidelines state that the QI cannot be a family member, accountant, attorney, or real estate professional who has had any financial relationship with the exchanger in the last two years. If you choose an ineligible QI, you'll risk the transaction losing its tax-deferred status.

It's important to note that the industry for qualified intermediaries is mostly unregulated. So, it's essential to do your due diligence before using the first firm you find online.

#2 Failing to Claim 1031 Transaction Status Before Selling the Relinquished Property 

The investor never handles the money in a like-kind exchange. That's where a qualified intermediary comes into play. As the investor, when you initiate the first property sale, you must tell your escrow agent that the transaction is part of a 1031 exchange so they can direct sale proceeds to your QI. If you receive money from the sale, you'll lose the tax-deferred status of a like-kind exchange.

#3 Not Finding the Right Team 

The complexity of a like-kind exchange comes with significant benefits. But unless you're a real estate professional or someone that has already gone through the process a few times, you may find yourself lost in a sea of 1031 requirements.

Building a team that consists of a real estate agent, tax professional, and qualified intermediary can help. With the right support team in place, you can easily understand the 1031 exchange rules and quickly identify replacement properties that meet your requirements, ensuring you meet necessary deadlines.

#4 Waiting to Sell Before Looking at Replacement Properties 

From the day you sell your relinquished property, you have exactly 45 calendar days to identify suitable replacements, one of which you'll eventually purchase. However, if you wait until you finalize the sale to look for a replacement and push it too close to the deadline, you could find yourself with a property that's not what you wanted. Or worse, you could face paying capital gains taxes if you can't complete the transaction within the set deadlines. Instead, it makes sense to work with a real estate professional who can help you identify multiple replacement properties that fit your budget and ensure you take full advantage of the tax benefits of the like-kind exchange.

#5 Not Adhering to Exchange Deadlines 

A 1031 exchange can fall through if you don't strictly follow IRS deadlines. From the sale date of the relinquished property, an exchanger has 45 days to identify the replacement property (or properties) and 180 days to close the deal. Failure to comply with the 45- and 180-day deadlines means you could forfeit the tax-deferred status of the transaction and be held accountable for paying capital gains taxes.

The Bottom Line 

When done correctly, a 1031 exchange is a tool that helps real estate investors upgrade to more lucrative properties while deferring taxes. However, if an investor falls into one of these common mistakes, like failing to find a suitable QI or waiting too long to identify replacement properties, it can jeopardize the whole transaction. 

So, if it's your first like-kind exchange, be sure to get a team of professionals in your corner who can help you get it right from the start.

Source: iQuanti