Sec. 1031 Combination Exchanges
In the past, we’ve touched on the numerous variations of Section 1031 like kind exchange transactions. We’ve discussed the standard, delayed 1031 exchange. We’ve also covered the other, less common variations, such as the improvement exchange and reverse exchange. As it turns out, there is another variation which we have yet to explore. The so-called “combination exchange” is perhaps the least common Sec. 1031 variation. This transaction, often referred to as a “stacked exchange,” combines both the reverse and delayed Sec. 1031 variations.
A Time Limit to Complete Transactions
As we know, the taxpayer in a delayed exchange has a total of 180 days to complete his or her transaction. The combination exchange enables a taxpayer to have a maximum of 360 days to achieve full tax deferral. Time always has value, and so the combination exchange can be perfect for the right situation.
In this post, we will go over the mechanics of combination exchanges and then discuss a hypothetical scenario. Combination exchanges can be a very useful means to avoid taxable boot. Occasionally, a taxpayer may be unable to spend all of his or her cash in a typical reverse exchange. The combination exchange allows the taxpayer to overcome this dilemma. If a taxpayer is focused on achieving full tax deferral, the combination exchange may be of assistance achieving that end.
Combination Exchanges Are a Hybrid Transaction
As its name implies, the combination exchange is an amalgam of two different exchange variations – the delayed and the reverse. An “exchange last” reverse exchange begins when a replacement property is acquired by an exchange accommodation titleholder (EAT). When an EAT acquires title to a replacement property, this begins a 180 day clock. More about this time constraint can be found in Revenue Procedure 2000-37. Suffice to say, though, for our purposes, that the taxpayer has 180 days to sell his or her relinquished property. After the the sale of the relinquished property, the replacement property is transferred from the EAT to the taxpayer.
In most cases, this transfer of the replacement property would finalize the 1031 transaction. But what if the taxpayer desires to acquire additional replacement property in order to achieve full tax deferral? We can conceive of scenarios in which the initial reverse exchange fails to defer 100% of the tax liability. In such situations, the taxpayer may utilize the additional 180 days triggered by the sale of the relinquished property. A taxpayer need not end his or her transaction after selling relinquished property in a reverse exchange.
Section (k) Treasury Regulations
Pursuant to the Section (k) Treasury Regulations, the sale of relinquished property starts the 180 day clock in a traditional delayed exchange. This is true even if this particular relinquished property is part of a reverse exchange. Hence, the sale of relinquished property may be the beginning of a delayed exchange or the end of a reverse exchange. Let’s look at a hypothetical example to get a better sense of combination exchange mechanics.
A Hypothetical Combination Exchange
For the sake of simplicity, let’s leave out closing costs in this hypothetical. Let’s suppose that a taxpayer has a relinquished property with an adjusted basis of $500,000 and a value of $1.2 million. To defer all of this $700,000 gain, the taxpayer needs to acquire a property worth $1.2 million. Suppose that the taxpayer locates a replacement property, but it only has a value of $700,000.
Let’s further assume that market realities necessitate that this replacement property be acquired in a reverse. When the EAT closes on this $700,000 replacement property, the 180 day clock starts. The taxpayer then must identify his or her relinquished property and then sell this property within 180 days. Let’s assume that the taxpayer stretches things to the last minute and sells just before the 180th day. Does the taxpayer have to pay taxes on the $500,000 which will come back to him or her? The answer? Not necessarily, because he or she can elect to initiate a new delayed exchange.
A New 180 Day Clock
The taxpayer can develop a new delayed exchange to acquire more replacement property. The sale of the relinquished property would start the new 180 day clock in this new delayed exchange. The taxpayer must then fulfill all of the normal requirements of a standard delayed exchange. Hence, the taxpayer would need to comply with the ID requirements, receipt requirements, and so forth. The taxpayer could conceivably acquire another $500,000 of replacement property on the 180th day of this new delayed exchange.
180 + 180 = 360 Available Days
In this hypothetical, the taxpayer would achieve full tax deferral as all of the exchange proceeds would be spent. And the taxpayer would have utilized a total of 360 calendar days to accomplish this feat. This hybrid exchange of both reverse and delayed variations would be classified as a combination exchange. As can be seen, this is an incredibly useful tool in the right scenarios.
A NYC Tax Attorney Can Help
The potential usefulness of combination exchanges is the sort of counsel you can expect from Mackay, Caswell & Callahan, P.C. We work hard to make sure that our clients have access to the best possible tax advice. And, in many cases, this means going the extra mile and doing advanced research.
Digging through the nuances of Section 1031 isn’t easy, but this is the sort of thing which spells value to clients. When you work with us, you can be certain that you’ll receive the best possible counsel. If you need assistance with a 1031 exchange or other tax issue, please contact our top New York City tax attorneys today. We will review your case and point you in the right direction immediately.
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