Common Mistakes That Can Invalidate Your 1031 Exchange
At the Law Offices of Peter V Lathouris LLC, we help clients make confident, informed decisions throughout all stages of real estate transactions. One of the more powerful tools in real estate law is the 1031 exchange, which allows property owners to defer capital gains taxes when exchanging like-kind properties.
When done correctly, this strategy can support long-term investment growth. However, there are many pitfalls that can completely invalidate the exchange.
Our firm has over three decades of experience guiding clients in Stamford, Connecticut through the intricate requirements of real estate law, and we understand the serious consequences that even one mistake can create. That’s why it’s so important to understand what to avoid.
Missing the Strict Timelines
One of the most common mistakes involves misunderstanding or missing the strict deadlines that apply to a 1031 exchange. The IRS provides very little flexibility in this area, which means timing errors can eliminate the tax benefits entirely.
There are two critical deadlines to keep in mind:
The 45-day identification period: Within 45 days of selling the original property, we must identify potential replacement properties in writing.
The 180-day purchase period: We must complete the purchase of the replacement property within 180 days of the sale.
Failing to meet either of these deadlines voids the exchange, and the gain from the sale becomes taxable. To avoid this, we encourage early planning and constant documentation.
Failing to Use a Qualified Intermediary
Another essential requirement in real estate law involves the use of a qualified intermediary (QI). We cannot receive or control the proceeds from the sale of the original property. Instead, the funds must be held by a QI until they are used for the purchase of the replacement property.
Mistakes that often happen with QIs include:
Choosing someone who doesn't understand IRS rules.
Attempting to act as your own intermediary.
Letting a real estate agent or attorney handle funds directly.
The IRS views any constructive receipt of funds as invalidating the 1031 exchange. To stay compliant, we make sure to work only with QIs who meet all legal standards.
Identifying the Wrong Property
The replacement property must be of "like-kind," but that doesn’t mean it has to be identical. It must be similar in nature and use, not necessarily in quality or location. Misidentifying a property that doesn’t qualify under IRS rules can cancel the exchange.
Common identification errors include:
Listing properties that aren’t actually available.
Failing to properly describe the property.
Exceeding the allowed identification limits.
There are specific rules around how many properties we can identify. Under the Three Property Rule, we may identify up to three properties, regardless of their total value. Alternatively, under the 200% Rule, we can identify properties as long as their total value doesn’t exceed twice the value of the original property. These guidelines must be followed exactly.
Using the Wrong Entity for the Transaction
Consistency matters in 1031 exchanges. If the property was owned by an individual but purchased by a different legal entity—or vice versa—the IRS could reject the exchange.
We often see issues arise when clients hold title in the name of an LLC, trust, or partnership but try to buy or sell under a different name. The party selling the relinquished property must be the same party purchasing the replacement property.
To avoid issues with title mismatches, we:
Review ownership documentation early.
Confirm that the purchasing entity matches the seller.
Recommend early discussions with accountants or advisors.
Getting this right is key to compliance with real estate law and tax rules.
Spending Too Little on the Replacement Property
To fully defer capital gains taxes, the replacement property must be of equal or greater value than the relinquished property, and all proceeds must be reinvested. Spending less or pocketing part of the proceeds may result in a taxable event.
Partial exchanges are allowed, but they reduce the tax deferral benefits. When planning an exchange, we:
Calculate fair market value.
Consider closing costs and fees.
Structure the deal to align with reinvestment goals.
This is one of the more overlooked areas in real estate law. Many people think partial reinvestment is enough to qualify, but it usually results in partial taxation.
Improper Handling of Personal Property
A 1031 exchange must involve real property, not personal property. Including furniture, fixtures, or equipment in the sale or purchase can jeopardize the tax deferral.
For example, if we’re exchanging apartment buildings and the replacement property includes a large amount of personal property (appliances, for instance), that portion of the value could be taxable.
To manage this, we:
Clearly separate personal property from real property in contracts.
Work with qualified appraisers when necessary.
Allocate value properly in the closing documents.
Understanding the difference between real and personal property is vital in real estate law compliance.
Mistakes With Partnerships or Joint Ownership
Exchanges involving partnerships or fractional ownership can be especially tricky. When multiple owners are involved, there must be full agreement on the exchange, or the IRS may see it as an invalid transaction.
Issues that often arise include:
One partner wanting to cash out.
Disagreements about replacement property.
Structural changes to the partnership during the process.
We’ve seen how these complications can delay or derail a deal entirely. To reduce risk, we:
Clarify ownership interests from the outset.
Draft exit strategies before initiating the exchange.
Handle disputes with clear documentation.
These steps support smoother coordination and help keep the exchange in line with federal real estate law.
Using 1031 Exchanges for Flips or Personal Use
It’s important to understand that 1031 exchanges are meant for investment or business property. They cannot be used to defer taxes on property held for resale or for personal use.
Mistakes occur when someone:
Buys a property with the intent to flip it.
Moves into the replacement property shortly after purchase.
Fails to demonstrate investment intent.
We counsel our clients to hold the replacement property for a reasonable period, typically at least one to two years—to reflect investment use. Any indication that the property was never truly held for investment can undermine the exchange.
Ignoring State-Specific Requirements
Federal rules govern the 1031 exchange process, but state laws may also impose additional conditions, especially concerning tax treatment.
For example, some states require:
Separate filings or disclosures.
Withholding taxes unless a valid exchange is completed.
Use of in-state qualified intermediaries.
Because we're based in Stamford, Connecticut, we stay informed on both federal and state-level real estate law requirements. Missing a state-specific step can result in unexpected penalties or delays.
Poor Communication Between Parties
Real estate transactions already involve many moving parts. Adding a 1031 exchange makes coordination even more important. Poor communication between sellers, buyers, real estate agents, intermediaries, and lenders can lead to misunderstandings and errors.
To streamline the process, we:
Hold regular update calls with all parties.
Confirm timelines in writing.
Manage document submissions and deadlines.
When we keep everyone on the same page, we reduce the chances of procedural mistakes.
Failing to Consult With Legal Counsel
Lastly, perhaps the most significant mistake we see is failing to speak with someone experienced in real estate law before starting the process. A 1031 exchange is a tax-deferral strategy, not just a property transaction, and it comes with significant regulatory requirements.
Even well-intentioned investors can fall out of compliance without realizing it. Our firm’s legal guidance helps:
Identify risks early.
Draft compliant contracts.
Work with tax professionals to structure the deal.
Respond to disputes or IRS inquiries if they arise.
Real estate law is detailed, and with high-value investments on the line, we believe it's always worth securing legal support.
Reach Out to a Real Estate Lawyer
If you're considering a 1031 exchange or you're concerned about past transactions, we're here to help. At the Law Offices of Peter V Lathouris LLC, we serve clients throughout Stamford, Connecticut, and across Fairfield County and New Haven County, including Darien, Greenwich, Norwalk, Danbury, and Westport. Contact us today to protect your investments and make smart real estate law decisions.