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Have you heard the phrase “Prior proper planning prevents poor performance”? Well, prior proper planning is crucial to completing a successful 1031 exchange. Many investors make the mistake of not planning ahead and working with a Qualified Intermediary who would be able to help them prepare for their exchange.
Mistake #1: Not engaging a Qualified Intermediary (QI) prior to closing
We receive calls a couple times a month from investors who have just sold their investment properties and want to complete an exchange, but they failed to contact a QI prior to closing. The QI must be in place and the exchange must be set up PRIOR to the closing of the sale. Since the investor failed to do so, they are unable to complete an exchange and are staring at a large tax bill.
Mistake #2: Failing to identify properties by the 45 day deadline
45 days goes by really fast! Many investors do not plan ahead and end up failing to find properties they can purchase as part of their exchange. The IRS requires the taxpayer to identify the replacement properties within 45 days of the closing of the sale. Many investors are not able to identify properties by the deadline or identify properties that end up falling through after their identification date (they are unable to add new properties after the deadline). The key to avoid this mistake is to plan out your exchange and start looking for your replacement property early on in the process so as to avoid issues with the deadline.
Mistake #3: Not meeting the reinvestment goal
There is a common misunderstanding with 1031 exchanges that you only need to reinvest the gain on the sale. This is incorrect and will result in a taxable event for the investor. The IRS allows the tax deferral with a 1031 exchange, but in order to defer 100% of the gain, you must buy a property(ies) equal or greater in value to the property you sell. This is referred to as the Reinvestment Goal. The easiest way to calculate it is by taking your sales price minus your closing costs. This equation will give you the number of what needs to be reinvested in order to achieve complete tax deferral. As long as you reinvest equal to or greater than that amount, you will be able to fully claim the deferral through your exchange. Any amount short of this number will result in a taxable event for the investor.
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