TO COMBINE OR NOT TO COMBINE - THAT IS THE QUESTION
What the title of this blog refers to is whether or not it makes sense to sell or buy more than one property in a single Section 1031 tax-deferred exchange. First we must establish the fact that more than one property can
be sold and/or purchased within one 1031 exchange. In other words, I
can sell two or more properties and combine those sales into one
exchange, out of which I can buy one replacement property. Likewise, I
can sell one property and buy two or more properties as my replacement
property in an exchange. Or I can sell two or more propertes and buy
two or more properties as my replacement property in a single exchange.
Many times clients or potential clients
contact us with questions about the benefits and the hurdles when
considering whether to combine multiple properties into one 1031
exchange. Let's try to break it down. Here are some questions to
consider when making such a decision:
Regarding multiple relinquished properties:
- Will my relinquished properties all close at once, or within a short period of time? (If so, it will make combining them into one exchange much easier.)
- If not, am I sure that they will all close with enough time remaining to complete the exchange within the 180 days allowed?
Regarding multiple replacement properties:
- Will I be able to complete the purchase of all replacement properties within the 180 day exchange period?
Regarding multiple relinquished properties AND multiple replacement properties:
- Will my relinquished properties close in a sequence that will allow
me to close on the replacement properties in accordance with my
purchase agreements and/or the sellers' requirements?
As I often say when discussing Section 1031 exchanges, sometimes an
example or two is better than all of the explanation in the world.
For the first example, let's assume that I own two properties and
each one is worth $150,000. I would like to sell both and purchase as
my replacement property one larger property valued at $300,000. Doable,
to be sure, but there are some potential pitfalls. Let's say my first
sale closes on January 1. This establishes the beginning date of the
exchange, which means it will end 180 days later on June 30 (assuming
we're not in a leap year). The seller of the property I want to buy is
willing to wait until April 1 to close. On March 15, the date the
second sale was scheduled to close, the buyer of my second property
runs into difficulty obtaining financing, or worse, backs out of the
agreement. The seller of the property I want to buy may allow me an
extension, but he may not. Even with an extension, if the second
relinquished property doesn't close in time to allow me to close on the
property I want to buy, my exchange is in serious jeopardy of failing.
the second example, let's assume the reverse: I own one property that I
am selling for $300,000 and I want to purchase two properties, each
worth $150,000. This setup is usually less problematic than the first
example, but there still can be issues. Let's again say that closing of
the relinquished property occurs on January 1. My exchange account is
opened with $300,000, and I identify only the two properties that I
want to purchase as my potential replacement property. On March 15, I
close on the first property. However, the second property has a cloud
on the title, or there is an environmental issue that must be resolved.
There could be any number of possible problems that could keep the
second property from closing. (This is one reason to always identify a
reasonable number of potential properties during the ID process,
subject of course to the limitations that the rules impose, so that you
have a fallback plan if something prohibits you from closing on your
first choice.) If the issues preventing the purchase from being
completed are not resolved prior to the end of the exchange period on
June 30, my exchange will only be partially successful and I may have a
sizable tax bill for the money I could not put into the second property
I had planned to purchase.
The answer to the question of whether you should combine properties
into one exchange or not is the favorite answer of all advisors: It depends.
With proper advance planning and careful oversight, it is entirely
possible to complete a successful exchange with multiple properties on
either or both sides of the exchange; we do it on a regular basis for
our clients. But do your homework and make sure your ducks are in a row
before entering into what is typically an endeavor that carries a
little more risk than a regular one-property-for-one-property Section