What Happens If You Die in the Middle of a 1031 Exchange

It is not a comfortable question, but for older investors it is a practical one. A 1031 exchange can take up to six months. What happens if the investor dies after selling the relinquished property but before buying the replacement?

The short answer is that the exchange does not automatically fail. In most cases the estate can complete it. The longer answer involves deadlines that do not extend, executors who may not know an exchange is under way, and tax questions that need professional advice quickly.

Can the estate complete the exchange?

Generally, yes. The estate steps into the decedent's position, and the executor or personal representative can direct the Qualified Intermediary to acquire the identified replacement property, or identify property if the 45 day period has not yet ended.

The exchange agreement usually binds the intermediary to act on behalf of the exchanger's successors. The estate is treated as continuing the same taxpayer for exchange purposes, which is one of the few situations where the identity of the owner changes without breaking the same taxpayer rule.

Do the deadlines change?

No. The 45 day identification period and the 180 day exchange period continue to run from the original closing date. There is no automatic extension because the investor died.

This is the most serious practical risk. An executor may not be appointed for weeks, may not know the exchange exists, and may not have authority to act immediately. By the time anyone looks at the paperwork, the identification deadline may have passed.

What if the executor chooses not to complete it?

The estate may decide not to complete the exchange, for example because the heirs want cash or the identified property is no longer suitable. In that case the exchange fails and the gain on the original sale is generally recognised.

How that gain is taxed, and whose return it appears on, depends on the timing and facts. The sale took place while the investor was alive, so the gain arose before death rather than after it. That generally means the step up in basis that applies to property owned at death may not erase gain that was already realised on a completed sale. This is technical territory and needs a CPA's advice promptly.

Does completing the exchange help the heirs?

It can. If the exchange is completed, the deferred gain carries into the replacement property. The tax consequences of that for the estate and heirs, including whether and how a step up in basis applies to the replacement property, depend on the timing and on how the transaction is characterised.

Because the answers turn on details, families should get advice before deciding whether to complete the exchange, and ideally before the identification deadline.

What should investors do now?

If you are older, in poor health, or simply prudent, a few steps protect your family:

• ›Tell your executor and family when an exchange is under way, including the intermediary's name and the deadlines
• ›Keep copies of the exchange agreement with your estate documents
• ›Consider a durable power of attorney that allows someone to act on the exchange if you become incapacitated
• ›Hold title in a revocable living trust where appropriate, so a successor trustee can act without waiting for probate
• ›Identify replacement property early, so the estate has something to complete if needed

What about incapacity rather than death?

Incapacity can be even more awkward, because nobody may have authority to sign documents. A durable power of attorney that clearly covers real estate and exchange transactions can allow an agent to complete the exchange. Without one, a court process may be needed, and the deadlines keep running.

What should an executor do first?

If you are an executor and discover an exchange in progress:

• ›Contact the Qualified Intermediary immediately and provide proof of authority
• ›Find the closing date of the relinquished property and calculate day 45 and day 180
• ›Check what has been identified and whether it can still be acquired
• ›Consult the estate's CPA and attorney before deciding whether to complete the exchange
• ›Document every decision and date

What if death happens before the relinquished property closes?

That is a different situation. If the investor dies before the sale closes, the property is owned at death, and heirs generally receive a stepped up basis to fair market value. If the estate then sells, there may be little or no gain, and an exchange may be unnecessary.

The estate can still choose to exchange if heirs want to keep real estate, but with a stepped up basis the tax benefit of doing so is often small. Many families in this position sell for cash and divide the proceeds, or buy what they want without the constraints of an exchange.

How do DST interests fit into estate situations?

Delaware Statutory Trust interests acquired through an exchange are often easier for estates to handle than a directly owned building, because management is professional and interests can be divided among heirs. They are illiquid, however, and heirs generally cannot sell them on demand. Estates should review the offering documents for transfer procedures at death.

What to do first

If you are in the middle of an exchange now, send a short note to your executor or trustee with the intermediary's contact details, your closing date and your deadlines. If you plan an exchange soon, check that your estate documents allow someone to act quickly on your behalf.

Nothing here is tax, legal or investment advice. The tax treatment of exchanges interrupted by death is technical and fact specific. Confirm your position with your CPA and estate attorney.