Year-End is Here Again; Let's Revisit 1031 Exchange Year-End Planning Issues

It seems like I was just writing this same 1031 exchange year-end planning post toward the end of 2007. Did twelve months actually just come and go, again?

End of Year Near
Well, here we are once again. We are now just shy of two months before we celebrate the end of 2008 and welcome in the new year of 2009. What a year 2008 has been, and what a year 2009 will be. I'm actually typing this as I'm watching the election results begin to unfold on CNN.

1031 Exchange Year-End Planning
I'm going to ignore the election results right now since the results will not affect our discuss about 1031 exchange year-end tax planning, unless you have a 1031 exchange that fails or will otherwise not qualify for tax-deferred exchange treatment. The capital gain tax rates for 2009 might be substantially higher than what we have been used to over the recent past few years.

1031 Exchange Fails at Year-End
Anyway, ignoring the election for now, it is time to discuss 1031 exchange year-end tax planning for those 1031 exchanges that fail to qualify for tax-deferred exchange treatment. The question is what happens when you begin your 1031 exchange during 2008 and it fails because you were not able to locate and identify suitable like-kind replacement property or you were not able to actually acquire the property identified? The answer may surprise you!

Section 1031 of the Internal Revenue Code Works in Conjunction with Section 453
So, you have a 1031 exchange that started in 2008 and then failed. When do you recognize and pay taxes on the sale? Can you still defer the payment of the capital gains at all? These are all important questions that can have significant income tax consequences. The answer to this question depends on when you have the legal right to receive access to your 1031 exchange funds.

If your 45th day identification period and/or your 180th calendar day exchange period end in the following income tax year and the 1031 Exchange Agreement contains the appropriate language to restrict your right to access the funds, the depreciation recapture would be recognized and taxable in the year you sold your property (2008) and the capital gain would be recognized and taxable in the following year (2009) when you have the legal right to access your 1031 exchange funds.

The failed 1031 exchange works like an installment sale transaction pursuant to Section 453 of the Internal Revenue Code. Your capital gain is not taxed until the following year because you do not have the right to receive the proceeds until the following year provided the 1031 exchange documents are drafted correctly.

Save the Failed 1031 Exchange with a Deferred Sales Trust
You might also qualify for the Deferred Sales Trust™ if your 1031 exchange documentation was properly structured prior to the sale of your relinquished property closing.