David Moore, Equity Advantage 1031 Exchange, finds metaphors extremely helpful in explaining complex tax strategies. In a recent video, he likened common Exchange pitfalls to stepping on a banana peel: even small oversights in the Exchange process can lead to a costly fall. The example he shared involved a seller who had owned a property for years and spent roughly $50,000 preparing it for sale. Despite their preparations, they lost all of the benefits they were expecting due to poor planning for their Exchange.
This article takes a deeper look at this incident and discusses not only the causes of this “banana peel curse,” but how to avoid it in your own Exchanges and what to do if you’ve already slipped. If you own investment real estate or are considering a 1031 Exchange, read on to make sure you’re not making any missteps that could jeopardize your Exchange.
The Banana Peel Curse that Cost $50k: What Happened?
David’s story was short, but would make any investor shudder: a long-time investor sold their property after investing about $50,000 to get it market-ready. They put an immense amount of preparation to maximize the return on their investment, but missed the most important preparation of all: doing due diligence on their Exchange planning. In the end, the seller’s oversights led them to lose the out on value of their investment.
“You got to be careful, right? Don’t step on it, you fall down. And 1031’s one of those things where you need to plan ahead, really take care of things, know what you’re doing up front and work to do the right thing because there are opportunities to blow a transaction up.”
1031 Exchanges are wonderful way to protect your investment but require serious planning to ensure they are done correctly. Miss a step and the result can be a large, unexpected tax bill or the loss of tax-deferral opportunities.
Where to Look for the Banana Peel: Common Causes of Exchange Failure
There are several common places where even responsible property owners can “slip up” and lose out on their 1031 Exchange. The most common include:
- Poor planning on intent and timing. The IRS evaluates whether the property was held for investment or not. If a property was held primarily for sale (e.g., a flip), it may not qualify.
- Constructive receipt of sale proceeds. If funds move improperly or the seller has access to proceeds, the Exchange can be disallowed.
- Failing to reinvest enough (creating taxable “boot”). To fully defer tax, you must reinvest in replacement property of equal or greater value and debt (after normal transactional costs).
- Incorrect treatment of repairs and prep costs. Many closing or repair costs are treated as non-exchange expenses, meaning they can affect net proceeds and tax exposure.
- Missing the 45- and 180-day deadlines or identification rules. Timing errors are frequent and costly.
- Using the wrong facilitator or not consulting early enough. An Exchange facilitator should be an independent third party and should be engaged early in the process.
Example: How $50,000 Can Be “Lost”
Imagine an investor who owned a rental for years. They spend $50,000 on renovations to make it attractive for sale. The property sells for a good price, but because the seller didn’t: (a) plan the Exchange with a Qualified Intermediary, (b) reinvest the total sales price in a replacement property, or (c) understand which costs constitute boot versus allowable exchange expenses, the result can be considered taxable gain. In short, the seller gets the net cash benefit of their $50,000 work but they pay taxes on those gains that could have been deferred.
How to Avoid Banana Peels: 1031 Exchange Fundamentals You Must Know
Before attempting an Exchange, there are a number of fundamentals you must incorporate into your plan to prevent slip-ups later:
- Like-kind requirement: Real property held for productive use in a trade or business or for investment can be exchanged for other real property of like kind. The form of property matters less than its character as investment or business property.
- Qualified Intermediary: A third-party Exchange Facilitator (not your escrow company, agent, or attorney acting as both agent and facilitator) must hold proceeds to avoid constructive receipt.
- 45-day identification rule: From the date of closing on the relinquished property you have 45 days to identify potential replacements in writing.
- 180-day acquisition window: You must close on the replacement property within 180 days of the relinquished property closing.
- Reinvest sales price and equity: To fully defer, reinvest the sales price and carry equal or greater debt. Any reduction is taxable boot.
- Timing & intent: The IRS looks at how the property was used and your intent at acquisition. Short hold periods or flip-like behavior can jeopardize qualification.
Slippery Costs: Which Count as Exchange Expenses and Which Can Trip You Up?
Knowing which closing and pre-sale costs are considered “Normal Transactional Costs” is crucial to protecting your investment during a 1031 Exchange. Normal Transactional Costs can typically be paid with Exchange funds and treated as Exchange expenses (reducing boot). Expenses that often qualify include sales commissions, escrow fees, title insurance, legal fees, and recording fees.
However, other costs are non-exchange expenses and taking money out for these will create taxable boot if the funds come from Exchange proceeds. Examples include rent prorations, utilities, mortgage insurance, homeowner dues, and (importantly) many repairs or termite work. The classification of specific items can be nuanced, but, basically, spending money prepping a property without clear planning for Exchange treatment can increase taxable exposure.
A Practical Checklist to Help You Avoid Exchange Slip-Ups
Before you list, sell, or commit to any move, run through this checklist to protect your Exchange:
- Engage a reputable Exchange Facilitator early. Tell them your timeline and improvements so they can structure the Exchange. David Moore and Equity Advantage recommend proactive planning rather than reactive fixes.
- Confirm your property’s Exchange eligibility. Document how it was used (rental records, leases, ads) to establish investment intent if needed.
- Understand which improvements are capitalized versus repair expenses. Document major improvements and discuss tax impact with your CPA.
- Never take constructive receipt of proceeds. Use a Qualified Intermediary or a Qualified Escrow Account. Dual signatures and isolated accounts limit risk.
- Plan replacement property identification: Know your 45-day and 180-day windows and identify potential replacements unambiguously.
- Match sales price and equity: To avoid boot, purchase replacement properties equal to or greater than your relinquished property’s sales price and equity, net of transactional costs.
- Consider a Reverse Exchange if necessary. If you must close on the replacement before selling the relinquished property, a Reverse Exchange can work, but it’s more complex and expensive.
- Document everything and consult professionals. Keep copies of invoices, contracts, and communications. Coordinate with your CPA, attorney, and Exchange Facilitator.
What If You Already Stepped on the Peel? Options to Recover or Mitigate
Not every misstep is fatal. Here are a few options depending on the situation:
- Partial Exchange + pay boot: If you reinvest only part of the proceeds, you can still do a partial Exchange and pay tax on the boot. It’s not ideal, but it limits overall tax exposure.
- Delay and restructure future purchases: If the replacement acquisition hasn’t closed, talk to your facilitator. There may be ways to reallocate funds or adjust financing to meet the reinvestment test.
- Reverse Exchange or improvement Exchange strategies: If timing or improvements are the problem, alternative Exchange structures may salvage the tax-deferral opportunity, though they are costlier and require planning.
- Accept and plan for tax impact: Sometimes paying tax now and moving forward with a clean strategy is the best path. Work with your CPA to minimize the hit through proper accounting of basis, costs, and credits.
Why Working with Equity Advantage and David Moore Matters
David Moore and the team at Equity Advantage 1031 Exchange emphasize a proactive, consultative approach. They’ve handled thousands of Exchanges and stress these points:
- Engage early: the facilitator should be part of the planning team, not an afterthought.
- Use trusted processes: Qualified Escrow Accounts, fidelity bonds, and clear procedures reduce the risk of constructive receipt and mishandling of funds.
- Customize the Exchange structure to your goals: delayed, reverse, or improvement Exchanges each have trade-offs and costs.
Key Takeaways: Don’t Let a Small Oversight Cost Thousands
When working with investments and taxes, even small oversights in the process can be extremely costly. However, the banana peel curse is easily avoidable, especially when you have the right help. To ensure your Exchange goes smoothly, remember to take these steps: plan early, document intent and use, involve a reputable Exchange Facilitator such as Equity Advantage, understand which costs affect taxable boot, and respect the 45- and 180-day timelines. If you’re unsure whether your property qualifies or how a $50,000 prep budget might affect your Exchange, consult your CPA and an experienced Exchange Facilitator before you list.
Resources and Next Steps
If this article raised questions for you, take these next steps:
- Contact Equity Advantage 1031 Exchange.
- Gather documentation about property use, improvements, and receipts before talking with professionals.
- Discuss repair vs. capital improvement classification with your CPA to understand tax consequences.
- Explore whether a Reverse or Improvement Exchange fits your timeline if you need to buy before you sell or want to fund improvements post-acquisition.
Step Carefully, Plan to Avoid a Slip
While the thought of stepping on a banana peel in real life is laughable, in real estate tax planning it is no joke. The banana peel in David Moore’s story is a reminder to treat Exchanges like a coordinated, legal transaction that requires early communication, documented intent, a Qualified Intermediary, and knowledgeable advisors.
If you’re thinking about selling investment property and want to preserve your tax deferral options via a 1031 Exchange, reach out early. A quick planning call, 503-635-1031, to Equity Advantage could prevent a costly slip.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031
