1031 liquidation

[Lee Schram]

Hi BP,

Need help with a 1031 question.

On a 1031 election, can you liquidate the proceeds prior to the ending of the 180 day period requirement without penalty?

If so, are there specific situations that allow you to?                                                               

[Wayne Brooks]

"Liquidate the proceeds prior to the 180 days"?  The 180 days is the max time to buy the replacement property.  Not sure what the question is?

[Robert Hetsler]

Generally yes you can if you are talking about IRS penalty.  Depending on timing of the entire exchange and process it is possible but failing to meet deadline or changing your mind in the process does not automatically result in penalty in and of itself.

[Lee Schram]

To clarify the question, 

we are in the 89th day of the 180 period and need to liquidate completely the proceeds with the escrow company. 

Our attorney is informing us that we can not liquidate and request the respective funds.  

is our attorney correct that we can not liquidate the funds?

[Robert Hetsler]

Have you asked your attorney why and what he is relying on when providing you that advice?

[Lee Schram]

the attorney just said to us no exceptions.  No explanation further, just said there are no exceptions. 

I figured i would pose the question to the BP community and see what they have to say.

[Dean De Pew]

First off… I am not an attorney. For your own protection, you have to do your own due diligence… I thought when I read your question, I completely understood what you were asking…. Based on the answers of the other’s, maybe I don't understand the question at all... Here's what I think you are asking... The 1031 exchange, IRS Tax Code 1031, is a way to re-invest the proceeds from the sale of an appreciating asset without suffering a taxable event. Any taxation is deferred until final liquidation, (theoretically, several exchanges later, when you are in a more favorable tax position.) The way you make sure that all of this comes together correctly, is to be sure to use the "Safe Harbor" of a 3rd party facilitator. If you use a registered 3rd party facilitator, the infernal revenue, views it in a totally different light, than if you try to do it yourself. If a registered facilitator is holding the funds, they (the IRS) assumes it is being facilitated correctly and they will pretty well leave you alone. Or so they say...? If you do it yourself, as I understand it, you are almost guaranteed an audit. With a 1031 Exchange, you have a maximum of 180 days to roll the proceeds of the previous "Items" (key verbiage), sale into a new, "Like Item", without a taxable event. (Item meaning real estate for real estate, airplane for airplane, numismatic coins for coins, gem stones for gem stones... etc.) If you exceed the deadline, this is treated as an incomplete 1031 exchange and a taxable event occurs. Just like there would have been, if you did not enter into a 1031 Exchange, back when you sold your interest in the Item in the first place. I am certainly not certified as a 1031 facilitator, but as I understand it, there is no minimum time limit to liquidate the proceeds. If you do that, the proceeds are treated just like they would have been treated if, you had not entered into the 1031 exchange in the first place. Short term, long term whatever your tax position was, at the time of the sale, it is treated the same as it would have been. I think what council may have been trying to say is, You cannot receive the proceeds from the sale prior to the 180 day timeline….. “Without a taxable event.”. Perhaps, council neglected to mention those last 4 words. Hmmm. Regardless, if you receive the proceeds at all… Before, during or after the 180 day timeline, it is treated as a taxable event. Even if you only receive a check and hand it over to a facilitator, without cashing it, that is viewed as “constructive receipt” and there is a taxable event. The other consideration is, what will the facilitator charge you for the “broken” exchange? They don’t work for free. Never dealt with a broken one??? Long answer, but I think this answers your question. Good luck.

[Lee Schram]

@Dean De Pew

thank you for the detailed response.  

I will reach back out to the attorney 

[Dave Foster]

@Lee Schram, your QI is in a tough position because their professional standing and in many ways the success of all their exchanges rest in how they treat your exchange.  The Service is very clear that once a 1031 is begun the proceeds must remain in the hands of the QI until the end of the exchange period.  So for them it is critical that they not be seen as only strawmen for your exchange dollars and that they attempt to rigidly follow the code.  While the failure of a 1031 does not result in any additional penalties there are some potentially dire consequences available for fraudulently entering into a relationship with a QI.

However, that being said there are some creative ways to work around the situation.

1. If you would have closed the sale in between the middle of November and the end of the year and didn't turn in a 45 day identification form your exchange would end and your proceeds liquidated in a new tax year so the tax liability would have been deferred a year

2  The same effect can be gained by purchasing all the properties on your 45 day list and being past the 45 day identification period

3. Lastly, the exchange period is actually defined as the earlier of 180 days or the date of your next tax filing.  For most of our clients who want the full 180 days the remedy for that is to file an extension.  However, if 4/15 exchange end date helps you then don't file the extension and your exchange will terminate then.

Your QI does not want to inconvenience you but you have to give them some cover so they can never be seen as complicit in the act of setting up an exchange with no intent to complete.  

[Robert Hetsler]

I agree  with the post prior to mine but I understood your post to mean something changed around day 89 and "have to" to liquidate your account.  If that were a client of mine and it was through no fault of the client and it was just a substantial change in circumstances and they need the cash and can no longer continue with the exchange the sign a document that explains that to them and they get their money back.  So, as original posts is understood correct to mean "you have to"  then you need to advised your QI of the change and reason, sign some sort of release and I cannot imagine, provided you are not under an existing contract to purchase property already, then I think you might receive a different response

[David Krulac]

@Lee Schram

If you call off the 1031 and cancel the exchange, the penalty is that you would have to pay the capital gain tax on the relinquished property and pay your Qualified Intermediary, what you agreed to pay them.