Tax implications of failed 1031

7 Replies

I initiated a 1031 on October 18, 2017 (a flip I owned for 4 months), and now realize it may fail.  However, I've already filed a 2017 return.  Will the sale be recognized by the IRS as a short-term capital gain in 2017, or will it automatically be considered an installment sale because the 1031 won't officially fail until April 16, 2018?  Could I possible end up owing interest on top of the cap gain?

@Avery Goodman If you have filed your 2017 return, you have stopped the ability to proceed with your 1031. Since the sale transaction took place in 2017 it is considered a 2017 transaction and therefore we recommend that taxpayers file an extension OR complete their 1031 exchange prior to April 15th.

If a property is held for one year or less, then sold for a gain, the short-term capital gain will be taxed at ordinary income tax rates. If an asset is held for more than one year, then sold for a gain, the long-term capital gain will be taxed at a maximum rate of 20%.

The proceeds you receive from the sale, when the QI releases your funds, will be treated as ordinary income for 2018.

Thanks for the helpful response, Lauren.  Just so I understand you, even though I sold the property (that I owned less than one year) in October, 2017, the proceeds from the sale will be taxed as 2018 income? 

@Avery Goodman

Avery: Have you considered utilizing a monetized installment sale or something of the like to defer the taxes? Exchanges can fail for a number of reasons (as you're finding out). If your sale is greater than $500,000, it might be a good option.

@Avery Goodman ,  It is a little known but handy trick to begin an exchange with a sale in one tax year understanding that the exchange may not come to fruition.  You're basically shifting the date of gain recognition.  In that event you do file your 2017 tax return which does not report the 1031 since it was still active when you filed.  This can be a good fall back position in a failed exchange as you're discovering 

You did not have receipt of your proceeds so no tax was recognized until 2018.  So you would in deed treat it like an installment sale  with all the proceeds coming to you in 2018.  Tax due with you filing of the 2018 return.

There is the issue of the 2017 1099 that may not have been reported on your return as installment sale.  Your accountant may want to amend and reconcile that 1099 with the installment sale.

By the way - another quirk of the 1031is exactly as @Lauren Speidel  said.  Your exchange period is the lessor of 180 days or the date of your next tax filing.  By filing before your exchange was complete you've put yourself into amendment territory either way I think. 

@Avery Goodman

I initiated a 1031 on October 18, 2017 (a flip I owned for 4 months)

You cannot use a 1031 on a flip at all.  1031's are for investments only, and a flip is not an investment.  @Dave Foster doesn't this apply here?

@Jon Holdman , well that is a potential issue. His phrasing of it even more than the actual length.  There's no statutory holding period so I was guessing that his intent had been to hold for productive use and something happened to change that intent.  But you're right if by "flip" he really meant flip - the primary intent of resale then the exchange wouldn't have been appropriate anyway.

Exactly right, @Dave Foster , I misspoke - -while I did end up selling the property within four months, the intent when purchased was to hold the property as investment.

And thanks, Dave, for your advice about the amended 2017 return -- I'll talk to my CPA about that.

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