Introduction: Over the past several decades of practicing real estate law I have had many clients, both domestic and foreign, ask me to apply for an extension of a like-kind exchange deadline. My response has always been that this is impossible; IRS Section 1031 deadlines are unchangeable and inviolate. Other than rules for military personnel, terrorist attacks and federally declared disasters, there has been no general relief from these deadlines until the recent issuance of IRS Notice 2020-23.
Key Concepts. A like-kind exchange is highly beneficial to taxpayers because it provides for a deferral of tax and allows all of an investor’s capital and the deferred tax to remain invested in real estate today. In a nutshell, the property that you sell to begin the process is called the “relinquished property”. The net proceeds from the sale are deposited with a “qualified intermediary”, which are then used to purchase a “replacement property” which has been previously “identified” by the taxpayer. The last two of these steps — the identification of the replacement property and the closing of the purchase of the replacement-property — must be completed within strict program deadlines in order to qualify for the tax deferral.
Example: In 1995 our taxpayer purchases a fixer-upper apartment building in the Upper West Side of New York for $2,000,000 by borrowing $1,500,000 and bringing $500,000 to the closing table. He depreciates the improvements on his tax returns over the years but also makes capital improvements such that in the year 2020 his adjusted tax basis is the same as his initial purchase price of $2 million. Over the years, he has paid down his mortgage and owes about $1,000,000 on the property in 2020. Our taxpayer is now older and wants to retire to Florida. He sells his apartment building on the Upper West Side for its now present value of $5 million and the net proceeds of approximately $4 million are deposited with a qualified intermediary ($3 million of capital gains and $1 million of non-taxable return of capital). These proceeds are subsequently used toward the purchase of an apartment building in Florida at a cost of $5 million. The net effect of this transaction is that the taxpayer pays no capital gains tax on the $3 million of capital gains realized on the sale of the relinquished property; however, the taxpayer’s cost basis in the new property in Florida is only $2 million (a carry-over basis). If the taxpayer were to sell the property the next day for its present value of $5,000,000, there would be $3 million of long-term taxable gain upon which he would have to pay tax.
Usual Deadlines: There are two main deadlines when it comes to a section 1031 transaction. Upon the sale of the relinquished property, the taxpayer has 45 days in which to identify the replacement property. This is accomplished by sending a simple form to the qualified intermediary listing the potential replacement property. The other deadline is 180 days in which to close on the purchase of the replacement property. Both of these deadlines are measured from the closing date of the sale of the relinquished property.
Extended Deadlines: Per IRS Notice 2020-23, if you are in the midst of a 1031 exchange and your 45-day identification period or 180-day exchange period is set to expire sometime between April 1st and July 14th of 2020, you will get an extension until July 15, 2020. In other words, if you closed on the sale of the relinquished property between February 14, 2020 and June 1, 2020, you will have until July 15, 2020 to identify the replacement property. Likewise, if you closed on the sale of the relinquished property between October 4, 2019 and January 17, 2020, you will have until July 15, 2020 to close on the purchase of the replacement property.
The Future: The relief provided by Notice 2020-23 is not typical for disaster relief extensions, including 1031 exchanges. The IRS would usually refer to Revenue Procedure 2018-58 and provide an “affected taxpayer” with an extension of at least 120 days on their identification and/or exchange period deadlines. There is a lot of active industry lobbying in this area and we will keep you informed of any new developments.
This article is not intended to provide tax, legal or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.