How to Mitigate the Consequences of a Failed 1031 Exchange

mitigate consequences of a failed 1031

What are some ways that you can mitigate the adverse tax consequences of a failed or partially failed 1031 exchange? In this blog, we'll offer some strategies by examining a recent transaction that one of our clients did in Rochester, MN.

A 1031 Example

Recently we had a transaction in Rochester Minnesota where the taxpayer sold a $2,000,000 replacement property, and identified four million dollars of new replacement properties. After the 45th day had elapsed, their due diligence investigation of the replacement properties turned up some issues that made them rethink whether they really wanted to buy that replacement property.

In the end, those folks in Rochester Minnesota decided not to buy the replacement property, and so they were stuck thinking “well if we don't buy the replacement property we're going to have to recognize that gains on the sale of our old relinquished property. What are some things that we can do to alleviate the potential tax hit that we've got coming this year?”

Mitigating the Gain

A couple of different strategies can be used to offset or mitigate the tax gain. One of them is to use your exchange funds to buy interests in oil and gas exploration - what are called intangible drilling expenses.

By buying investments that have an immediate tax deduction for the intangible drilling rights you may spend a dollar but receive back $0.75 or $0.80 of immediate tax deduction. If you invest heavily enough in oil and gas exploration that you're allowed at least enough deductions to offset the gains that you’re incurring, you may be able to offset or wash all of the gains that you experience from the sale of your relinquished property by manufacturing immediate tax deductions through the intangible drilling rights.

  • 1031 Hotline: If you have questions about how to mitigate the consequences of a failed exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.


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