What Are Other Downsides to a 1031 Exchange I Can Tell a Seller?

[Burt L.]

I've been speaking to a seller who relocated out of state due to work in June, 2011. He lived there for at least 2 years, so if he sells before June, 2014 he can avoid the capital gains tax. His current lease with tenants expires in December, 2013 and I've mentioned that if he renews the lease he will lose the benefit of the Section 121 Capital Gains exclusion as of June, 2014. Thus it would be wise to sell before the lease expires this December or he will be trying to sell a rented property from out of state by June, 2014. I've also mentioned the increasing Section 1250 depreciation recapture at a combined 29.6% state and fed rate that the Cap Gain Exclusion does not avoid.

His response is that he will do the oft-mentioned Sec. 1031 exchange. This is his only rental property, and an unintended one at that. I was in a forward 1031 exchange and could not find a suitable replacement property and the Qualified Intermediary would not refund my monies despite not having to do the exchange. Another downside is that you have to hold the replacement property until you pass away to continue avoiding the tax.

I also like the phrase to not "let the tax tail wag the investment dog". I also know that if you let the sellers of the replacement property know you have to close by a certain date on this property, they may find a reason to raise the price. Lastly, I understand that in a couple of isolated instances a the Qualified Intermediary has simply stolen the funds from the first sale.

Are there other downsides to doing a 1031 exchange? People seem to view them as such a permanent tax solution. I sold another property and chose to pay the tax instead of dealing with the 1031 rules and another property that I wouldn't have sought other than for the tax avoidance of the previous property.