Investor seeks guidance for pandemic times
days to identify one or more replacement properties, and you have no more than 180 days to close on one or more of those identified properties.
Here’s how the 1031 exchange process is supposed to work: Let’s say you sold your property on March 2. Under the standard 1031 exchange rules, you’d have until April 16 to identify your replacement property or properties, and you’d have to close on those new properties on or before Aug. 28. Mid-March, COVID-19 hits and you either can’t find replacement properties or the virus has made it difficult to get to or view properties. Unless the IRS gives you a break, you’d lose the benefits of the 1031 exchange.
Those benefits include deferring the payment of any taxes on the profits from the sale of your property and delaying the repayment of any recapture of depreciation to which the IRS would be entitled. If you owned the original property for 20 years, and have taken depreciation for those years, and your profit is huge, your tax liability to the IRS would be enormous. A 1031 exchange allows you to defer paying those taxes down the line, and it is possible you never have to pay them under certain situations.
But back to your question. Due to the COVID-19 pandemic, the IRS has issued a change to the deadlines. Notice 2020-23, the declaration by the President of an Emergency Declaration, has given those with 1031 exchanges underway relief with some of the 1031 deadlines. If your exchange timeline requirements fall between April 1 and July 15, the deadline would be extended to July 15. In the example above, this would allow you to identify properties to purchase until July 15.
With much going on now, things are in flux. It would help the buyer in this example to have until July 15 to identify the property and then close no later than Aug. 28. But you expressed concern regarding an exchange that was completed last year. You seem to imply that your tenant wants to move out and you want to move into this property. We doubt you’ll get any relief from the IRS for that issue from this newly issued set of rules.
These rules can and might change at any time, so we don’t know where they might end up as many tax deferred exchange companies are lobbying for greater changes to these IRS 1031 legal requirements.
The IRS won’t look fondly on you taking an investment property and converting it into a personal residence. However, the tax hit may not be as bad as you think. Your intent when you undertook the sale and exchange of properties must have been for investment purposes and you didn’t know that the coronavirus was coming, so we suspect that your tax return from last year would show the 1031 exchange and you’d have deferred the taxes on that sale.
If you convert the home to your residence and then sell the property, you likely won’t be able to use a 1031 exchange to defer any profits or taxes owed. At that time, your tax situation would be complicated as you’d be selling the investment property and your home. You’d probably end up having to pay taxes on the investment side of your sale, but if the home was your principal residence, you might get some benefit from the $250,000 home sale exclusion rule.
We don’t have enough space to go over all the tax implications, but we’d rather give you a small taste of what you might face going forward. For more information, you’ll need to talk to an accountant, an enrolled agent, a tax adviser or a 1031 specialist to go over your situation.