When a Failed 1031 Exchange Crosses Over to the Next Year, When Will I Be Taxed?

1031 exchange tax faq

In some cases, taxpayers who engage in a 1031 exchange will get back unused 1031 proceeds in the year following the sale of their relinquished property. This could happen at the end of their 180 day exchange period because they were not able to (or decided not to) purchase all of their identified replacement properties.

For example, a person may start their exchange in August of 2015 and later receive their unused 1031 funds in January of 2016. When this happens they may wonder when they are going to be taxed on the money - in 2015, the year that the sale occurred, or in 2016, when they actually received the money.

Treasury Regulations

The Treasury Regulations for Section 1031 allow people to elect to treat a tax deferred exchange as an installment sale to the extent that the person receives cash (known as “boot”) in a subsequent tax year. This can happen if the exchanger fails to acquire some or all of their replacement properties, leaving cash boot in the hands of the qualified intermediary until the year following the sale. The cash received from the qualified intermediary at the end of the exchange period may be treated as a payment in the year it is actually received by the person for purposes of the installment sale reporting rules rather than in the year the relinquished property was sold.

On the Other Hand...

Any liens, deeds of trust, mortgages or other debts that were paid off on the sale of the relinquished property are treated as a payment in the year of the sale (when they were discharged or assumed by the buyer). Nevertheless, the tax deferral allowed by the interplay between Section 1031 and the installment reporting rules under Section 453 can produce a really nice tax advantage where gain must be recognized as the result of a wholly or partially failed exchange resulting in some unused 1031 funds going back to the seller.  Basically, it amounts to a potential one-year deferral on the gain on the returned unused cash proceeds.

  • 1031 Hotline: If you have questions about taxes relating to 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.


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