Searching for that perfect replacement property.
There are three principal reasons why Section 1031 Exchanges fail:
- A failure on the Exchangor’s part to identify property choices by the 45th day
- The choice of Replacement Property becomes unavailable, with no backup identified
- A failure on the Exchangor’s part to acquire such identified property by the 180th day (as adjusted).
The first of these can be eliminated by the Exchangor carefully selecting and identifying potential Replacement Property prior to closing on their Relinquished Property. This can be easier said than done. Often times, the Exchangor has a specific property in mind for the replacement and fails to continue her search for backup replacements.
Sometimes, the sheer pace of the transaction dictates that the sale has to be consummated (and closed) before the Seller (Exchangor) can begin to think about what the replacements will be. But this is VERY DANGEROUS, because at closing, the 45 and 180 day clocks begin to tick. And, up until the moment of sale, the Exchangor has been thinking like a Seller, not like a Buyer, and once the process of finding a new property begins, sticker shock can rapidly set in.
Add to this the complexities of buying out of state or in an unfamiliar market or in a time of year full of holidays (such as the period just before Christmas), and the 45 available days just seem to fly by. These days are CALENDAR DAYS, not business days, so with year-end (or any other legal) holidays inside the time period, these days can be and often are lost to the Exchangor.
So the lesson on the first point is this: The Exchangor at least needs to pay heed to the 45 day Identification Requirement well BEFORE committing to sell the Relinquished Property. When making this commitment, arrange to delay the closing if possible. If necessary, lease it to the Buyer, and give them possession, but do not give up legal title until preliminary identifications have been made. Do not, however, give the Buyer the “Benefits and Burdens” of actual ownership, just possession under a lease. In this way, the 45-day Identification Period can be effectively postponed.
The lesson on the second point is this: Before the Exchangor lists potential Replacement Property, do some DUE DILIGENCE. Many Exchangors identify a perfectly sound Replacement Property only to later discover something wrong that could have been ascertained beforehand. One client identified two properties, one with a toxic waste problem, and another on leased land (with too short a lease; 30+ years is required for this), so it wouldn’t close on the former and couldn’t close on the latter.
These and similar situations can be completely avoided with a REVERSE EXCHANGE (see Case Study #2 or Case Study #5), wherein the Replacement Property is thoroughly investigated, vetted and closed upon, using a Special Purpose Entity (SPE) before the Relinquished Property is dressed up for a sale.