Tax-Straddling Windows of Opportunity.
Between July 5th and December 31st there are two windows of “tax-straddling opportunity” that exist – July 5th through November 16th and November 17th through December 31st. Relinquishing between July 5th and November 16th will create a tax straddle only if the 1031 client has appropriately “identified” the replacement property that will be targeted for acquisition during the Exchange Period.
Fulfilling the identification requirement is vital because an exchange that lacks this required step, during this window, will cause the exchange to fail in 2006. Once the identification process is completed, the 1031 transaction will either allow for the successful acquisition and deferral of gain or the unsuccessful completion of the exchange attempt.
If unsuccessful, the failure will occur in 2007 because the intermediary holding your 1031 funds will be unable to release them to you until the Exchange Period has elapsed. The elapsing of course occurs in the desired year of 2007. While the July 5th through November 16th window commits a 1031 taxpayer to the “long haul,” the November 17th through December 31st window, in contrast, does not. Here, a failing 1031 taxpayer does not need to identify in order for the exchange to straddle into 2007 because the 45-calendar day Identification Period overlaps into 2007!
Caveat 1031 Client:
- The 1031 client must pass a “bonafide” intent requirement prior to being able to coordinate IRC Section 453 with that of IRC Section 1031 in an effort to receive the mini-tax deferral. The 1031 client should confer with his CPA or attorney to ensure that he has passed this test.
- If you are required to make quarterly tax payments in accordance with the Estimate Payment Rule, then it is best that you discuss this approach with your CPA. More than likely, this rule will dilute, if not wash away, the tax-straddling benefit.
- If you are a partnership, then your CPA should be reviewing Revenue Procedure 2003-56. Simply stated, this procedure will require that the gain that is attributable to the relief of debt, when the relinquished property was disposed of (sold), be recognized in the year that the property was relinquished. The theory being that the relief of debt is equivalent to the receipt of cash. Since this benefit of cash must be recognized in the year in which it was received, the tax-straddling approach may only be applicable to the 1031 equity (net proceeds) that is escrowed with the intermediary.
“So there are failures and then there are survivors! Which are you?”
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