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With so many exchanges facing the same deadline, there is very real potential for unintended consequences.
As a result of the COVID-19 pandemic the IRS issued Notice 2020-23, which provided a multitude of tax extensions, including 1031 like-kind exchange deadlines for some investors.
While the extensions were provided for good reason, there may be unintended consequences if eligible investors all wait to pull the trigger on their exchanges near or at the time of the deadline. Here’s a look at how that could happen.
The typical investor in a 1031 exchange has 45 days from the sale date of the original property to identify a replacement property, and 180 days from the sale date to complete the purchase of a replacement property. With the IRS’s new notice, the 45-day and the 180-day deadlines have been extended until July 15, 2020 for investors who originally had their 4th day or their 180th day fall between April 1, 2020 and July 15, 2020.
One example of how this could affect someone in a 1031 exchange would be if they had sold their property on April 3, 2020, in which case their 45th day would have been May 18, 2020. (They would have had to formally identify their replacement property by then.) Under the new guidelines, the same investor would have until July 15, 2020 to identify a replacement property.
More time is generally good, but if too many investors wait to effect their exchanges, the odds of unintended consequence are high. The possible outcomes? One may be that demand for quality exchangeable investment real estate exceeds the available supply in the first two weeks of July. If this happens, investors face fierce competition over replacement properties and could end up overpaying for choice assets.
Notably, many localities have seen a significant drop in real estate listings since the outbreak of COVID-19, so the supply of available replacement properties is below normal.
Another consequence is that if an investor waits to purchase a replacement property, the investor may not have enough time to complete their transaction. I don’t think we have ever had a time in America where so many 1031 exchangers had the same deadline date.
A good option for many 1031 exchange investors facing deadline pressure may be co-investment products such as DSTs (Delaware Statutory Trusts) because the financing and due diligence are already in place by the sponsor and it’s possible to complete a purchase in three to five business days typically. So clearly, tight market or not, there are now highly viable investment options for 1031 replacement property buyers.
Bottom line, many 1031 exchange investors are rightly taking a reevaluation of the marketplace in the midst of the COVID-19 pandemic, but with so many 1031 exchangers in America facing the exact same deadline on July 15, there is very real potential for unintended consequences.
Alex Madden serves as vice president of Kay Properties and Investments, which operates a 1031 exchange property marketplace.