What If Your 1031 Replacement Property Falls Through?

If your replacement purchase falls through, what you can do next depends on where you are in the timeline. Before day 45, you can revoke your identification and name a different property; after day 45, you can only buy from the properties you already identified, which is why backup properties matter so much.

Inspections, financing, appraisals and sellers can all derail a purchase. A failed purchase doesn't automatically end your exchange.

Why does day 45 matter so much?

Your exchange runs on two deadlines that start the day your relinquished property closes. (The relinquished property is the property you are selling.) Both count calendar days, including weekends and holidays, and they run at the same time, not one after the other.

• Identification period: You have 45 days to identify, in writing, the replacement properties you might buy.

• Exchange period: You have up to and including day 180 to complete your replacement purchase or purchases.

One detail catches people: the exchange period ends on day 180 or the due date of your tax return for the year of the sale, whichever comes first. If you sell late in the year, you may need to extend your return to get the full 180 days. Your CPA can tell you whether this applies to you. You can check your own dates with our 1031 Exchange Timeline Calculator.

What if the purchase falls through before day 45?

You still have room to adjust. Under the Treasury Regulations, you can revoke an identification at any time before the 45-day period ends. Then you can identify a different property.

A revocation has to meet the same formal standard as the identification itself:

• It must be in writing.

• It must be signed by you, the taxpayer.

• It must be delivered before the end of day 45 to the same party who received your identification, which is usually us as your Qualified Intermediary.

Don't wait until day 44 to make the switch. If the first deal looks shaky, start looking at alternatives right away so your new identification is ready in time.

What if the purchase falls through after day 45?

After day 45, your list is locked. You can only complete your exchange with property you identified on time, and there is no way to add a new one.

If you identified backup properties, you can move to the next one and close on it up to and including day 180. This is why we encourage clients to identify more than one property when the rules allow it. The identification rules give you three options:

The three-property rule

You can identify up to three properties of any value.

The 200% rule

You can identify any number of properties, as long as their combined fair market value doesn't exceed 200% of the value of the property you sold.

The 95% rule

If you go over both limits, the identification is still valid only if you actually acquire at least 95% of the total value of everything you identified. In practice, this is hard to meet.

For a full walk-through of how to write an identification that holds up, see our post on how to write a valid 45-day identification.

Can you buy a less expensive property instead?

Yes, if it is on your identification list. But buying less than you sold can create boot. Boot is any value you receive in the exchange that isn't like-kind property, such as leftover cash or a reduction in your mortgage debt that you don't replace. Boot is generally taxable, while the rest of your gain can still be deferred.

A smaller purchase isn't necessarily a failed exchange. It's often a partial one. Our post on partial 1031 exchanges explains how that works. Your CPA can run the numbers for your situation.

What happens to your exchange funds if nothing closes?

To keep your exchange valid, your exchange agreement has to limit your access to the sale proceeds. The regulations spell out when funds can be released to you:

• If you don't identify any property by day 45, the funds can be released after the identification period ends.

• If you identified property, the funds generally stay with the Qualified Intermediary until you have acquired all the replacement property you are entitled to, or until the exchange period ends.

The regulations also allow an exchange agreement to permit an earlier release after day 45 if a material and substantial contingency occurs that is spelled out in writing in the agreement and is beyond your control. Whether that applies depends on your agreement and the facts.

In practice, if your only identified property falls through after day 45, expect your funds to generally stay in the exchange until the exchange period ends. Once funds are released without a completed purchase, the sale is taxable.

Can a failed exchange push the tax into the next year?

Sometimes. The Treasury Regulations include a rule for taxpayers who started an exchange with a bona fide intent to complete it, using a Qualified Intermediary. If the exchange fails, the gain may be reported under the installment method in the year you actually receive the funds, not the year you sold.

For example, if your relinquished property closed in November and your funds are released the following year, the gain may be reportable in that following year. This depends on your facts, so talk with your CPA before relying on it. It helps to keep records of your efforts to buy replacement property, such as offers, contracts and correspondence.

How can you protect your exchange from a failed purchase?

Counting on a single identified property is risky. If it falls through after day 45, the exchange fails. This situation unfortunately plays out more often than it should. A few steps reduce the risk:

• Identify backups. If you are using the three-property rule, use all three spots when you have realistic options.

• Start looking early. Begin your property search before your sale closes so you aren't scrambling during the 45 days.

• Front-load due diligence. Schedule inspections, appraisals and loan approval as early as possible so problems surface before day 45, while you can still change your list.

• Match your purchase contract to your deadlines. Make sure the closing date and contingency periods fit inside your exchange period.

• Tell us right away. If a deal is in trouble, let us know. We keep the timeline and can walk you through your options while there is still time to use them.

Your next step

The best protection starts before your sale closes. Your exchange has to be set up before the relinquished property closes, and we can get most exchanges set up the same day. Setup starts by putting us in touch with your closing agent (your escrow officer, title company or closing attorney). Client items like a W-9 come after that. If you have a sale coming up, connect us with your closing agent and we'll take it from there.

APX 1031 is a Qualified Intermediary. We don't provide tax or legal advice; talk with your CPA or attorney about your situation.