In order to ensure that your 1031 exchange is successful, learn from the mistakes made by less than diligent taxpayers.
A taxpayer has a maximum of 180 days from the closing of the relinquished property or the due date of that year’s tax return, whichever occurs first, to acquire the replacement property. This is called the acquisition period.
In Orville E. Christensen v. Comm., the taxpayer sold property on Dec. 22, 1988, entering into a deferred 1031 exchange. On Feb. 3, 1989, the taxpayer notified the intermediary of 19 properties that taxpayer desired to acquire as part of the 1031 exchange. The replacement properties were acquired between April 25, 1989, and June 20, 1989. The 1988 return for the taxpayer was filed on April 17, 1989, since April 15 fell on a Saturday. The 180th day was June 20, 1989; however, since the taxpayer filed his 1988 return by the normal due date, the replacement property had to have been received no later than April 17, 1989. Accordingly the tax court held that since the due date of the return was earlier than the June 20th date, the transaction failed to qualify as a like kind exchange. As a planning consideration, the accountant for the taxpayer could have sought an automatic four-month extension, and the full 180 days to receive the replacement property would have been available. The taxpayer also could have considered changing the closing date of the sale of the relinquished property to January 1, 1989.
Similarly, in Raymond St. Laurent v. Comm., the taxpayer sold an apartment complex in Auburn, Maine, on Nov. 4, 1988 entering into a 1031 exchange. On Dec. 16, 1988, the taxpayer identified 20 properties. One of these properties was a 40-unit trailer park in Turner, Maine, and another was a vacant lot in Lewiston, Maine. Taxpayer closed on the trailer park on March 22, 1989, and the vacant lot on May 17, 1989. Taxpayer timely filed a Federal income tax return on April 15, 1989. He did not request an extension of time to file such a return. The exchange of the apartment complex for the trailer park was held to qualify as a like kind exchange. The exchange of the apartment complex for the vacant lot was not held to be a like kind exchange because the vacant lot was transferred after the due date of the tax return and 194 days after the taxpayer had transferred the apartment complex.
When dealing with 1031 deadlines are absolute; there is no good faith exception. Tax Court Judge Julian I. Jacobs held in Knight v. Comm. that a couple failed to receive replacement property within the time limit specified under Section 1031, disagreeing with the couple that Section 1031 requires only a “good faith” attempt to meet its timing requirements. David and Marilyn Knight argued that they were unable to timely close on the purchase of replacement property because a seller canceled the sale one day before closing. Although Judge Jacobs “sympathized” with the Knights, he pointed out that the court lacks jurisdiction to “rewrite” a more equitable result for them. The lesson to be learned from this case is that the taxpayer should not wait until the 179th day to close on the replacement property.
45-Day Identification Period
The 1031 Regulations issued by the IRS provide stringent requirements regarding identification of replacement property. These requirements must be met before the expiration of 45 days from the date the taxpayer sells its relinquished property. Identification of all replacement property must be made in writing, must be signed by the taxpayer, and must be delivered to the intermediary on or before the 45th day. The taxpayer may not identify replacement property after the 45th day. The taxpayer may identify as many as three properties, regardless of their total value (the “three-property rule”), or the taxpayer may identify any number of properties provided their aggregate fair market value on the 45th day does not exceed 200 percent of the aggregate fair market value of all your relinquished property on the date of its transfer (the “200 percent rule”).
Letters After Deadline Constitute Fraud
Dobrich v. Comr. is another example of the court’s refusal to bless all attempted 1031 exchanges. In 1989, the taxpayers entered into an agreement with a qualified intermediary to facilitate a like-kind exchange of their unimproved real property. A letter attached to the exchange agreement informed the taxpayers of the 45-day identification period.
In January 1990, after the expiration of the 45-day identification period, the taxpayers made offers to purchase two replacement properties, which they ultimately acquired. The taxpayer-husband then wrote a backdated letter to the QI purportedly identifying five replacement properties, including the two which were ultimately acquired.
The taxpayers’ accountant relied on these backdated and false letters in preparing the taxpayers’ income tax return for 1989, indicating thereon that the sale of the relinquished property qualified as a 1031 exchange. The returns for 1989 and 1990 were subsequently audited, and the letters were provided to the IRS. In addition to determining that the sale of the relinquished property did not qualify under 1031, the IRS asserted fraud penalties. Pursuant to a written plea agreement, the taxpayer-husband pleaded guilty to criminal charges of causing the delivery of false documents to the IRS. The taxpayers ended up paying $2.2 million in capital gain taxes and a $1.6 million fraud penalty!
