Are There Risks Involved with a 1031 Exchange? Carlsbad, CA

If you are considering a 1031 exchange, the very best thing that you can do to avoid the risks associated with the process is to hire a professional.

A 1031 exchange is an extremely useful tool that enables property investors and business owners to sell their investment property and reinvest in a replacement property while deferring the taxes that would otherwise be due. In doing so, those opting for a 1031 exchange will have more money available for investment – in a sense, it is like an interest-free loan from the government. These additional funds enable greater leverage to acquire properties that would have significantly higher investment benefits. In theory, this will benefit the IRS when it comes to selling your final property and paying taxes associated with it. However, in the meantime, you can potentially defer your property taxes indefinitely provided you meet the criteria for a 1031 exchange. 

Many people worry about the risks involved with a 1031 exchange, and this isn’t without reason. The process to complete a 1031 exchange is complex, and if you don’t do it right and abide by the strict rules and regulations surrounding this helpful tax deferment process, you could find yourself liable to pay both the capital gains owed on your property and any fines that the IRS might bestow. 

What is the Penalty for a Disallowed 1031 Exchange?

If a 1031 exchange is audited and found to be disallowed, the penalty standards that could be imposed include the income tax related to the sale of the relinquished property and the penalty and interest imposed on the underpayment of taxes. This is equal to the federal short-term rate plus an additional 3%. The accuracy-related penalty is equal to 20% of the substantial understatement of the tax, with the substantial understatement defined as the greater of $5,000 or 10% of the recognized gain. 

If you are found to have willfully evaded the tax with the intention of misleading, you could also have a fraud penalty imposed. This is 75% of the underpayment. 

Failure to Complete a 1031 Exchange

Aside from not meeting the necessary criteria for the exchange itself, such as selecting a like-kind property and appointing a qualified intermediary, there are also time constraints to consider. In fact, failing to complete on a 1031 exchange is one of the biggest risks associated with the process.

If the replacement property cannot be identified within the designated 45 days from the sale of the relinquished property, or has not been bought within the 180 days designated to purchase the replacement property (180 days total, not as some people believe 45 days plus 180 days), then your exchange will fail and you will be subject to capital gains taxes on the sale of your relinquished property. There are no loopholes and no exceptions. 


If you are considering a 1031 exchange, the very best thing that you can do to avoid the risks associated with the process is to hire a professional. Qualified intermediaries such as the team here at understand all of the rules and regulations surrounding 1031 exchanges and can offer our advice and support from start to finish, helping to ensure that yours meets all the criteria required to be a success.

Ready to get started?

We know that 1031 exchanges, real estate financing, and everything in between can be confusing, and a 10 minute phone call can help clear things up. So give us a call or schedule a consultation today, and we’ll be happy to talk through your specific needs.