On a failed 1031 exchange, capital gains are paid in which year?

Question

We have a property sold end of December 2017. If we were to not procure a replacement property by the 180 day mark in June 2018, there would be capital gains owing. Would we pay the capital gains for tax year 2017 or for tax year 2018? Asking because the tax deadline for 2017 is next week and wondering if this can be put off til 2018. Thank you in advance for any help.

Alan Rohrer · Answer

@Michelle R.

As you could imagine, with a 180 day period to close (half a year), this situation would likely pop up a lot.

First, be sure to talk with a tax advisor / CPA that knows your whole picture before you make any decisions (as there may be something I'm missing from your post).

But generally, if your funds in 2017 went to a qualified intermediary, and you had the full intention and ability to complete a 1031 exchange before the applicable deadlines, but weren't able to complete- the sale could be treated as an installment sale, and taxed in the year you received the proceeds (2018) from the qualified intermediary (when they paid you back the money they were holding).

Now- if you had any gain due to debt relief, or had any depreciation recapture, this would generally be taxed in the year of the sale.

I'd recommend hashing this out with your tax advisor/CPA as amending your return after the filing deadline if you end up owing more tax could cause you to incur some interest and penalties. You could also extend and file when you know for sure.

Hope this helps!

**Update** Looks like @Dave Foster also replied while I was crafting my message, and I will second what he wrote!

Dave Foster · Answer

@Michelle R.Your exchange must be complete by the time of your next tax filing.  Since you have not received proceeds at this point you can either abandon the exchange and treat the sale as an installment sale in 2017 with proceeds received in 2018 and tax due with your 2018 tax return.  Or you will file an extension for your 2017 return so that you can complete your exchange and then your accountant will file a form 8824 reporting the 1031 on the 2017 return.

Sometimes letting an exchange go isn't so bad when you're able to shift the date of the recognition of gain ahead one more year!

Michelle R. · Answer

Thanks, both of you. I will bring the depreciation recapture to the attention of my CPA for the 2017 extension. Good to know the failed exchange would be for 2018.