A Busted 1031 Exchange is a Painful Experience, Try This Strategy Instead

There is no doubt this is one of the hottest housing markets that we have seen in a long time. You don’t have to do Google search to hear about all the hype with home sales around the country.

Here is a Wall Street Journal article that I was featured in regarding this housing frenzy.

If you own real estate investments, this is one of those rare times where you may have great cash flow AND significant appreciation in housing value.

But maybe you’ve let deferred maintenance catch up to you. Or maybe you want more cash flow with additional units.

There are many reasons why you may want to sell and investment property. However, if you try to do a standard 1031 exchange in this housing market, it can wind up being a complete disaster. And when emotions and a great replacement property are on the line, you don’t want to be the one responsible for losing out on a great deal.

As a reminder, here is how a standard 1031 exchange works. In a regular 1031 exchange, you have an investment property you own that you want to sell and replace with another investment property, while potentially avoiding capital gains tax. That could even be selling a single family home for a triplex in another state.

Important and Strict Rules to Follow In a 1031 Exchange.

The first is that you have 45 calendar days after selling your investment property to identify a list of potential replacement properties. This list must be in writing and submitted to an intermediary. If this deadline is missed, the whole favorable tax-free exchange can go array.

The second is that you must CLOSE on the purchase of the replacement property within 180 calendar days after the sale of your old investment property. This is an extremely important detail to understand! You must have CLOSED on the new property within 180 days of the CLOSE of the old property.

Why is this important and what could go wrong?

Well, as a real estate professional you know what a seller’s market we are currently in.

How many offers are you competing with on homes? 10, 15, 40…

It’s not easy to get acceptance on a property right now. So, if you are on a required tight timeline, there are several problems that are likely to occur.

1.      You can’t find a property you like to replace the old property.

2.      You can’t get acceptance on a property. You keep throwing out offers, but the seller’s keep taking other offers ahead of yours.

3.      You are forced to get hosed on a property because you had to meet the deadline. The only way to get acceptance was to offer $100,000 over what you wanted, crushing your ROI dreams.

4.      You were exchanging for multiple properties. However only 2 out of 3 properties closed by the deadline, which still busts the exchange.

You get the point! Those rules to the standard 1031 exchange can make it very difficult in a hot housing market.

What should you consider instead?

Welcome the reverse 1031 exchange!

In a reverse 1031 exchange, you know it’s easy to be on the seller’s side with multiple offers and easy terms. But being on the buyer’s side is challenging to say the least!

To avoid losing the tax advantage of the 1031 exchange or to not make forced bad decisions due to time constraints, you should start by finding and buying your replacement property first. We know now that buying a desirable investment property or properties may take time, so find and purchase those first. There is no deadline on buying an investment property.

Then identify your own investment property that you wanted to exchange within 45 days to an intermediary in writing and begin the listing process. In this market, selling your property may take very little time and may not come up against the 180 day rule (unless you are being a little prideful in rejecting perfectly good offers- which can happen to the best of us).

None of what I am suggesting is extremely complicated, but most real estate investors don’t know that you can do the process in reverse. Or simply haven’t thought through the easily avoidable pitfalls.

Let this be one easy strategy that could potentially save you from a lot of stress, headaches, and heartaches. You may be able to avoid taking a big capital gains hit or lose out of that investment property of a lifetime by utilizing the steps listed above.

If you want to walk through your specific situation, I’m happy to offer some help!