The Situation
A real estate agent assisted a client with the purchase and sale of various properties as they upgraded from one property to the next. Typically, when you sell a property and have , you must pay tax on the gain at the time of the sale. However, under Section 1031 of the IRS Code, you can postpone paying tax on the gain if you reinvest the proceeds in a similar property as part of a qualifying like-kind exchange.
The agent advised the client to pursue a 1031 transaction due to the tax benefits. The client agreed, and the agent offered to coordinate the transaction. A property was purchased with the understanding that the Section 1031 tax benefit would apply.
The Mistake
The 1031 like-kind exchange documents were inadvertently omitted from the contract documents of the property being sold and the newly purchased property. Due to the oversight, the proceeds from the sale of the existing property were not placed into escrow with a qualified intermediary, and the tax benefits were lost. The client was responsible for paying a 15% federal capital gains tax and an 8% state capital gains tax.
The agent did not refer his client to a tax or legal expert. He also neglected to include the 1031 like-kind exchange documents in the contracts for both the sale and purchase of the properties. Moreover, the agent failed to read the closing documents and attend either closing, losing a final opportunity to discover the problem.
The Result
The client sued the agent for failing to include the 1031 like-kind exchange documents in the closings of both properties. The agent acknowledged his mistake, and the claim was settled for more than $50,000 shortly after the suit was filed.
Prevention
The agent should have referred his client to a tax advisor and/or attorney instead of offering to coordinate the transaction. In addition, the agent should have reviewed the closing documents to assure complete compliance with prior agreements and representations. Had the agent done so, he would have realized the 1031 like-kind exchange documents were missing.
The agent could have also created a checklist to confirm all requirements for both transactions were satisfied. Finally, attending the closings would have provided line of defense in the effort to assure the transactional paperwork was complete.
This article was produced in conjunction with XL Catlin and is not to be taken as legal advice.