Despite all the benefits of 1031 exchanges, the process is not without risk to investors. Understanding the pitfalls are important. The following are the rules and risks of 1031 exchanges:
- Once the offering is closed, there can be no future contributions of capital by either current or new co-investors or beneficiaries.
- The investor cannot renegotiate the terms of the existing loans or borrow any new funds from any other lender or party.
- The investor cannot reinvest the proceeds from the sale of its real estate.
- Any liquid cash held in between distribution dates can only be invested in short-term debt obligations, and all cash must be distributed to any co-investors or beneficiaries on a current basis.
- The investor is limited to making capital expenditures with respect to the property to those for normal repair and maintenance, minor non-structural capital improvements, and those required by law.
- The investor cannot enter into new leases or renegotiate current leases during the 1031 exchange process.
- The 45-day timeline for identification of the replacement property goes by quickly, and investors’ projects do not always go according to plan.
- The IRS stipulates that investors have 180 days after the sale of the relinquished asset to close on one of the previously identified replacement properties and complete the 1031 exchange. The 180-day window runs concurrently with the 45-day identification window.
In addition to the stringent timelines, there are other things that can make the 1031 process complicated. Choosing the wrong qualified intermediary (QI) is a huge risk for investors. These professionals facilitate the 1031 exchange by acquiring the relinquished property from the investor and transferring title to the buyer. They also acquire the replacement property from its seller and transfer title to the investor to complete the 1031 exchange process.
Fortunately, a lawyer can help reduce the risks of a 1031 exchange in several ways, including the following:
- Reduce timeline risks: An experienced lawyer knows the deadlines. They will ensure you satisfy the identification rules by midnight on that 45th day and that you understand when that 180th day is.
- Communication: A lawyer will keep you and any agents in the loop, aware of the time constraints, and discuss ultimate investments goals.
- Tax returns: Filing a tax return can artificially shutdown the timelines. If your transaction falls close to the end of the year, a lawyer will make sure to complete the transaction before a tax return is filed, and if necessary, file for an extension.
1031 exchanges are complex and come with certain risks. However, when handled by a skilled lawyer, real estate investors will be assured the benefits of a successfully executed 1031 exchange.
1031 Federal Exchange Helps Real Estate Investors with Exchanges
Our 1031 exchange services lawyers have vast experience in facilitating successful 1031 exchanges for our clients. Call us at 513-450-3039 or contact us online to schedule a free consultation. Located in Loveland, Ohio, we serve clients nationwide.