Can You Cancel a 1031 Exchange after Starting the Process?

Sometimes taxpayers are on the fence, and they’re not sure what they want to do when selling property. What if you want to cancel your 1031 exchange after the process has started?

Keep your Options on the Table

If you’re on the fence I suggest keeping all available options on the table. If you sill your property and take the cash, you’re going to have to pay the taxes. So rather than take the cash, set up the 1031 exchange and use the first 45 days (the identification period) to evaluate your options and see if you want to designate any replacement property. During those 45 days you can decide if you want to continue with the 1031 or not. If you don’t identify any replacement property by midnight on the 45th day, your exchange will fail and your QI should return the funds to you on the next business day.

After the 45 Day Identification Period

If you want to keep your options open after the 45th day all you need to do is make a valid written identification of what your replacement properties may want to purchase and then use the remaining 135 days to do your due diligence. You are still in the driver’s seat and can decide if you want to close on those properties. If you do you can use your exchange funds at any time to acquire the identified property. If you don’t want to close on them, it’s not a big deal. All you need to do is wait until the end of the 180 day period and receive your unused exchange funds at that time.

Contingency Identifications

Sometimes taxpayers want to make an identification with a material contingency. For example, you can identify a property but state that you don’t want to buy it unless it’s re-zoned commercial by a specific date. If the property is not rezoned by that specified date then the identification is void. The beautiful thing about making a contingent identification is that it gives you the option to fold up your tent and terminate your exchange if the contingency doesn’t occur.

Here’s a note though – you can’t make it contingent upon your negotiating a purchase price with the seller because that’s a contingency that’s in your control. You could just negotiate in bad faith and make the contingency not occur. The contingency has to be something that’s out of your control like getting a permit approval or zoning control.

• Start Your Exchange: If you have questions about cancelling 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Auctioning 1031 Exchange Property

Sometimes in a 1031 exchange, tax payers want to sell their old relinquished property at an auction. This happens most often in the realm of personal property like business equipment or muscle cars held for investment purposes. The taxpayer takes the property to an auction, puts it up on the auction block and hopes it sells. There are a few things to keep in mind when you’re buying or selling 1031 property at an auction.

Notify the Auctioneer

If you’re selling property at an auction it’s a good idea to have the auctioneer notify the bidders that this sale is part of a 1031 exchange and that whomever the winner is, they will have to sign an acknowledgement that states that the seller has assigned their rights in that purchase agreement to their QI (Qualified Intermediary). It’s a simple request, but you need to let the buyer know that they will need to cooperate with the 1031 exchange.

Buying Replacement Property at Auction

The same situation exists when you’re trying to buy your replacement property at an auction. You go to the action and tell the auctioneer that you’re doing a 1031 exchange and that you want the ability in your purchase agreement to assign it to your QI. So talk to the auction company and ask if you can include a 1031 cooperation clause in your purchase agreement (if you are the winner) so that you can elicit the seller’s cooperation. This helps evidence that you’ve satisfied the treasury regulations requirements for a 1031 exchange. In particular that you’ve assigned the contract to the intermediary and that you’ve given written notice to all the parties of the purchase agreement.

The problem with auctions is that you’re a person removed from actually dealing with the specific buyer or seller. So you need to have good and effective communication with the auction house so they can facilitate your request.

• Start Your Exchange: If you have questions about 1031 exchanges and auctions, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

The Napkin Test: Simple Rules for a 1031 Exchange

The napkin test boils down complex 1031 tax concepts into an easy to understand set of rules of thumb that help you decide if you’re going to defer all of your gains in a 1031 exchange. The napkin test sets up three benchmarks that must be satisfied in a 1031.

Value

The first benchmark of the napkin test is value. When you’re doing a 1031 exchange you need to have a continuation of investment into a new, bigger, better property. Imagine if you sold a property for a million dollars and acquired only a $10K replacement property. The surly IRS agent would look at you cross eyed and say:

“Hey, where’s your continuation of investment here? You’re $990k short of equal or greater value replacement property.”

So the first benchmark if you want to defer the tax is to acquire a replacement property of equal or greater value. Going up in value fixes a lot of problems that can occur from a tax perspective.

Equity

The next benchmark is equity. If you bought a million dollar replacement property but only reinvested $10K of proceeds (putting $990K in your pocket), again the IRS agent will say

“Hey, where’s your reinvestment of the equity. I see $990K in your pocket. We’re going to make you pay taxes on that.”

In order to satisfy the napkin test all of your net proceeds need to be reinvested into the replacement property. So we need to redeploy the equity instead of putting it in your pocket.

Debt

The last benchmark is debt. Imagine you pay off a $500k mortgage at the sale of your relinquished property and you’re taking the debt backpack off for the first time in years. That debt relief will trigger gain in your 1031 exchange unless you offset that debt relief by either taking out new debt of an equal or greater amount or by reinvesting cash out of your own pocket into the replacement property.

If you win the lottery on the way to closing on your replacement property, you could pay cash for the replacement property. That new cash-in will offset the debt relief dollar for dollar. Most taxpayers don’t win the lottery on the way to the closing and have to take on new debt on their replacement properties.

Here’s a hypothetical:

• We sell a property for a million dollars

• We pay off $500K of debt

• We net $500K in proceeds

If we buy a replacement property for 2 million dollars so we’ve gone up in value, we offset the debt relief of $500k with a 1.5 million dollar mortgage. We also redeploy all of our $500K proceeds. We have satisfied the napkin test by going up in value, equal in equity, and we’ve offset our debt.

• Start Your Exchange: If you have questions about the napkin test, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

How Much Does a 1031 Exchange Cost?

Many people ask how much it costs to do a 1031 exchange. That question is complicated because it depends on the services rendered and various other factors.

Price Should not Be Your Sole Criteria

As with any service, you can always find the low cost leader. I caution people to not have cost be the sole criteria because QIs (Qualified Intermediaries) are often not regulated or licensed by any state authorities. Anyone can call themselves a QI. If you aren’t confident that your QI is reputable and qualified, who knows where you’re sending your funds.

The small vanilla single 1-to-1 exchange where you’re selling one relinquished property in a standard deferred exchange and acquiring one replacement property might cost between $850.00 and $1,500.00. It depends on what level of service is being provided and the complexity of facilitating the exchange (how many properties are involved, etc.).

Safeguard your Funds

The most critical piece is to make sure that the safeguards are in place to protect your funds in the interim between the sale of your relinquished property and the purchase of your new replacement property. Both small and large QIs have been known to abscond or file for bankruptcy. When that happens, you may lose your money and have your exchange fail.

The primary consideration should not be cost. The most important thing is to safeguard the funds and to work with a reputable QI. Don’t choose the low cost option. Go with the tried and true QI that provides consistent and professional service. You may pay a little more but the peace of mind your receive is worth every penny.

• Start Your 1031 Exchange: If you have questions about the cost of your 1031 exchange and safeguarding your 1031 exchange funds, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Is Big Brother Watching your 1031 Exchange?

One of our clients recently asked the following question: "Can the Minnesota Department of Revenue force your Qualified Intermediary provide them with your private information relating to your 1031 exchange?" This is a common question among taxpayers who are considering a 1031 exchange. Read on to find out whether big brother is watching your 1031 exchange.

Minnesota Statute 289A

In the last few years, Minn. Stat. 289A.12 was amended to include a new subsection #16, which states:

Minn. Stat. 289A.12 Subd. 16. Qualified intermediaries. The commissioner may by notice and demand require a qualified intermediary to file a return relating to transactions for which the intermediary acted to facilitate exchanges under section 1031 of the Internal Revenue Code. The return must include the name, address, and state or federal tax identification number or Social Security number of each of the parties to the exchange, information relating to the property subject to the exchange, and any other information required by the commissioner.

This means that the Minnesota Department of Revenue can require your Qualified Intermediary to provide them with all of the key details of your 1031 exchange and any other information that they want. In other words, big brother is watching your 1031 exchange.

• Start Your 1031 Exchange: If you have questions about your private information involved in a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved