The idea of conducting a 1031 exchange is appealing to investors for a number of reasons, especially the tax-deferred nature of the transaction. Rather than paying capital gains tax immediately, an investor can trade up on investments and defer any tax liability for years. In some cases, where exchanged property is part of a decedent’s estate, capital gains can be effectively eliminated altogether.
So why are delayed exchanges – where replacement property is not closed on for weeks or months after the relinquished property is sold – so popular? Two main reasons:
- The exchanger enjoys additional time to find and close on the purchase of suitable replacement property. This replacement property need not be acquired (or even identified) when the relinquished property is sold. This alleviates pressure and allows the investor to find the replacement property that best suits his or her goals and objectives.
- Practically speaking, a delayed exchange ensures that the relinquished closing and replacement closing occur in the proper order, as current law requires. If a simultaneous exchange occurs in different locations, it is difficult – if not impossible – to ensure that the relinquished closing occurs before (or at the very latest simultaneously with) the closing for the replacement property.
Although simultaneous exchanges can – and do – successfully occur, the vast majority of 1031 exchanges today occur on a delayed basis. Unless the investor happens to find and negotiate the purchase of replacement property in the same time frame as the sale of the relinquished property (which rarely occurs), it makes sense to focus on a delayed exchange.