When a taxpayer is doing a 1031 exchange, they may want to buy their new replacement property together with another person. Maybe they want to buy the replacement property with their significant other or partner, for example.
The Problem with Proceeds
The problem with this generous idea is that in order for the exchange to be respected, all of the proceeds from the relinquished property need to be earmarked and used exclusively for that taxpayer’s exchange.
If the proceeds from the relinquished property are utilized to buy someone else's interest in the replacement property, the IRS will say:
"These funds were earmarked to buy the taxpayer’s interest in the replacement property but instead were used by someone else who is not the exchangor’s interest in the property. We don't see that as being a continuation of investment by the taxpayer.”
So you may inadvertently cause the recognition of gain as to any proceeds that were sidetracked and used to basically ante up someone else's interest in the replacement property.
The Best Course of Action
The better course of action is to have the taxpayer that relinquished the property use their proceeds solely for their purchase of the replacement property. If someone else is coming in as a cold purchasor they should bring in their proportionate share of the down payment and contribute their cash out of their pocket so that they have a place at the table that they pay for out of their own funds.
- 1031 Hotline: If you have questions about 1031 exchange funds, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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