1031 Timeline and the Placed In Service Date

[Margaret Feit]

I am currently in my initial 45-day identification period for a 1031 exchange. I'm looking at a property that needs a total rehab and considering using my 1031 funds to purchase the property and then adding outside funds to complete the rehab. I would plan to take title within 180 days, but I'm not sure I could have the rehab all the way finished and the property placed in service within 180 days, possibly not even within this calendar/tax year. I understand that any purchase involving the 1031 funds needs to be identified within the 45 days and completed within 180 days, but if I am also using outside funds for additional work, does that all need to be completed within 180 days as well? Does the property need to be placed in service by that time? 

If I wasn't using 1031 exchange funds for a project like this, I would just keep track of my expenses and let them build up as basis until the property is placed in service, at which point I would start depreciation based on the basis at the time it's placed in service. I wouldn't report anything about the property on my tax returns until that time. In this case, if I complete a 1031 in 2025 (with the 180 days being completed in 2025 as well), but I don't actually put the replacement property in service until 2026, how does that work with the tax return and depreciation schedule? How would I account on the 2025 tax return for a property that exists in the exchange but hasn't been placed in service?

[Dave Foster]

@Margaret Feit, You cannot 1031 exchange into improvements on property you own.  This creates a dilemma.  If you purchase you can't count later improvements.  And it's doubtful that the current owner would be willing to let you do improvements before you purchase it.

This is what a reverse exchange is for.  We create an entity that takes title to the new property.  We can hold it for up to 180 days while you then improve it using your 1031 proceeds.  And you then take title to the new property (by day 180 after your sale) at the value of the price of acquisition plus improvements.  That solves your whole placed into service depreciation schedule issue.

But reverse improvement exchanges are costly.  And if the purchase price of the new property is greater than the property you sold.  You might be better off putting all of the proceeds into the purchase of the property.  And then later doing a cash-out refi to get the funds to do the improvements.  Or take the extra cash from your exchange as boot and pay tax only on that amount.