1031 exchange:
That Magic Time of Year
Exchanges begun after July 5th, that magic time of year, bring into play a little known tax regulation under Section 1031. This regulation allows you to defer tax liability for one year even though a 1031 exchange fails. The general rule is that a 1031x must be reported on the tax return for the year in which the relinquished property sells. Therefore, an exchange started in 2006 must be reported on a 2006 tax return.
There is one exception. An exchange started in 2006, (but not completed by the end of 2006) can be reported in 2007 if the exchange then fails. The gain can be reported in the tax year in which it failed (2007), rather than in the year it was begun (2006).
To reiterate, the gain from an exchange started in one calendar year and still open at the end of the tax year which then fails in the next tax year can be reported in the tax year in which the exchange fails instead of in the year in which the exchange was begun. This rule can allow an exchanger to defer tax liability for a full year even if a 1031x fails.
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