A common misconception about 1031 exchanges is that they can only be conducted in one manner – a sale and then a purchase through a third party facilitator. In fact, 1031 exchanges have evolved to include numerous tax strategies and structures.
Advanced 1031 Strategies to Consider
Advanced 1031 exchange techniques – such as reverse exchanges, improvement (build-to-suit) exchanges, tenancy-in-common restructurings, Delaware Statutory Trust allocations, and related-party planning – can provide significant tax deferral and strategic flexibility when properly executed. However, these structures involve strict statutory timelines, complex Treasury Regulations, IRS safe harbor requirements, and heightened audit scrutiny under doctrines such as step-transaction and substance-over-form.
Even minor sequencing errors, improper title parking arrangements, or misalignment of debt replacement can inadvertently trigger taxable gain or IRS audit. Here are some common 1031 exchange issues that cause tax audits. For these reasons, investors should engage experienced tax counsel, a reputable qualified intermediary, and coordinated financial advisors before initiating any advanced exchange strategy to ensure the transaction is structured, documented, and executed in full compliance with §1031 and applicable IRS guidance.
Contact Moskowitz LLP today to discuss your 1031 exchange questions. We serve clients nationwide from our offices in California and Utah. Call us: (888) 829-3325 or fill out a contact form and we will reach out to you.
Simultaneous and Delayed Exchanges
Historically, the exchange of properties always occurred on the same day. Following the Starker decision in 1979, however, “delayed exchanges” became the norm. Now the purchase of replacement properties generally take place sometime after the relinquished property’s closing.
Reverse Exchanges – “Parking Arrangement”
A “reverse exchange” occurs when a replacement property is purchased and closed on before the relinquished property is sold. This permits an investor who has the financial resources to purchase a new property to benefit from the delayed sale of their relinquished property and take advantage of the ups and downs of the real estate market.
Use case: Investor wants to acquire the replacement property before selling the relinquished property.
Mechanics: An Exchange Accommodation Titleholder (EAT) “parks” either the new or old property.
Investor has: 45 days to identify the relinquished property 180 days to complete the exchange
Why it’s advanced: Requires Rev. Proc. 2000-37 compliance, special purpose entities, and non-recourse financing planning.
Improvement Exchanges
The benefits of IRC 1031 can also be utilized when improvements need to be made on a replacement property before it is received. Improvements may consist of repairs or of entirely new construction. To benefit from tax-deferred treatment, all improvements must be completed within 180 days or the investor risks being faced with a new property that is not of the same or greater value than the relinquished property – and with building materials that may be classified as “boot” subject to immediate taxation.
1031 Exchanges Involving Partnerships
Most 1031 exchanges nowadays involve partners that hold property jointly. It is not uncommon for a partner to want to dissolve their interest in a property held by the partnership. However, buying out that partner runs the risk of triggering substantial tax liabilities. There are a few options available to partnerships in cases where the partners’ respective interests diverge:
- Drop and swap. This involves the liquidation of the partnership interest in the property, which is then converted into an interest in the property as tenant-in-common with the partnership. The property is then sold, with each partner (and former partner) choosing whether or not to move forward with a 1031 exchange.
- Swap and drop. A “swap and drop” is the reverse of a “drop and swap.” The partnership completes an exchange and then distributes its interest in the replacement property to the exiting partner.
- Split-off. With a split-off, the partnership provides the departing partner with title as tenant-in-common, and the rest of the partners complete a 1031 exchange as a partnership. The departing partner can then cash out or exchange their tenant-in-common interest in the property.
Contact Moskowitz LLP
Real estate investors retain our services to ensure that they are maximizing their benefits from both a real estate and a tax perspective – they understand how crucial it is to hire 1031 exchange professionals who are experienced and proficient in both areas. The California tax attorneys at Moskowitz LLP can help you facilitate a successful 1031 exchange. Call us: (888) 829-3325 or fill out a contact form and we will reach out to you. We also provide expert representation with all types of tax audits, including audits in connection with 1031 exchanges.
