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Failed 1031 Exchange with A Happy Ending

Michael and Michelle owned a restaurant in a major city and the building housing the restaurant was a mixed-use property owned by Michael and Michelle in a separate LLC.  They sold the restaurant for $8million of which $4.2 million was attributed to the building.   The building had $2 million balloon debt on it mostly relating to renovation costs.

Unfortunately, at the closing, Michael and Michelle received a bank check for the sale of the building in the sum of $2.1mm after closing costs.  They had heard about the 1031 exchange strategy but had thought they simply had to reinvest the proceeds within 180 day and were unaware that by taking actual or constructive receipt of the sale proceeds, they were precluded from a tax-deferred exchange.

Their adjusted tax basis in the property was $1.8 million leaving them with a gain of $2.3 million and a tax liability of $735,000.

We conveyed the bad news that they missed the exchange, but working with their accountants, we were able to uncover $300,000 of passive activity losses (IRC  1231) from the sale of a prior investment property, leaving $435,000 which they placed in an Opportunity Zone Fund to defer their taxes until December 31, 2026 and possibly 2028 (pending legislation approval).  See more on Opportunity Zone Funds here.