Closed On The Sale Of My Real Estate: Can I Defer The Taxes With A 1031 Exchange?

This question is actually a very common question that our team of tax deferred and tax exclusion specialists receive virtually each and every day.  But, before jumping into the subject matter I wanted to make a general comment regarding this question.

Never, never, under any circumstances, structure and close on any real estate investment transaction, whether it is a purchase or sale, without consulting your legal and/or tax advisors first, so that you know what you are getting into.  

The bad news that I'm about to discuss regarding this subject could have easily been avoided if the investors involved had consulted with their tax advisors first and learned what the property steps were in order to structure a 1031 Tax Deferred Exchange. 

Already Sold My Real Estate

The calls fielded by our tax-deferred and tax-exclusion experts generally start off with a question that goes something like this:

I just sold my rental property and I want to defer the capital gain taxes, and I was told that I could do so with the 1031 Tax Deferred Exchange.

What Do You Mean By Sold?

The first thing that our experts do is define what the caller means by "sold."  Sold can mean many different things to many different people.  Sold could mean that they just listed their property for sale, or they just accepted an offer from a buyer, or they just closed escrow and the rental property has been deeded to the buyer.   We need to accurately determine exactly what stage the caller is at in his or her real estate transaction in order to determine whether a 1031 Tax Deferred Exchange will work.

Generally, sold means that the investor has accepted an offer to buy his or her property and he or she has a binding Purchase Agreement to sell the property to a specified buyer, or in other words, the investor is under contract, but it does not automatically mean that he or she has closed on the sale of the rental property.

Sale Must Not Have Closed

The most important issue that we are looking for is to make sure that the caller has not actually closed on the sale of his or her rental property.  By closing, I mean that the sale of the real estate has been completed, a settlement statement (HUD-1) has been issued, and the property has been deeded to the buyer of the real estate. 

It is too late to set-up a 1031 Tax Deferred Exchange if the sale of the real property has already closed and the buyer has the property.  The reason is simple.  The investor who is selling the property can not have constructive receipt or control over the net proceeds from the sale of the rental property.  They have the ability to direct the closing officer/agent/escrow officer where to direct the funds once the sale has closed and therefore have constructive receipt of the 1031 Exchange funds. 

Therefore, in order to properly structure a 1031 Tax Deferred Exchange the Qualified Intermediary used to handle the 1031 Exchange must be in place and "assigned" into the Purchase Agreement and related documents before the sale has closed in order to avoid the constructive receipt issue. 

So, going back to the original question.  It is too late to set-up 1031 Tax Deferred Exchange if the sale has closed and the property deeded to the buyer.  It is not too late, and you can defer the payment of your capital gain taxes with a 1031 Exchange, as long as the sale transaction is still in process and has not closed.