Most of the 1031 exchanges I've seen go sideways went sideways for reasons that were preventable. Not complicated tax law. Not unusual IRS positions. The same seven mistakes, repeating across decades of LA multifamily transactions.
Each one below has cost a real LA seller real money. The combined tax exposure across these seven failure modes, on a typical $5M to $10M LA multifamily gain, runs $500,000 to $2 million in avoidable tax. Knowing the patterns doesn't guarantee you won't make them — but it dramatically shortens the odds.
The 45-day identification clock is the most common failure point. Sellers arrive at Day 0 with no shortlist. They spend the first 15 days getting organized. The next 15 days touring properties with brokers they haven't worked with before. The final 15 days in hurried negotiation on replacements they wouldn't have chosen with more time.
The cost: Either the exchange fails outright (tax on the full gain) or the seller acquires a replacement property they regret for the next seven to twelve years. The former is expensive; the latter is more expensive over time.
The fix: Start the replacement search before the relinquished property closes. By Day 0, have 2-3 specific properties shortlisted. The 45 days is for diligence and term sheets, not for starting from zero.
To defer all tax in a 1031, replacement value and debt must equal or exceed the relinquished property's. Trading down creates "boot" — the difference is taxable immediately.
Common ways boot sneaks in:
- Replacement property is less expensive than the relinquished property
- Replacement property has less debt (unless you replace with cash from other sources)
- Cash received at close ("cash boot")
- Reduction in debt at close without substitution of cash ("debt boot")
The cost: On a $5M sale replaced with a $3.5M acquisition, the $1.5M shortfall is taxed at roughly 35-40% — approximately $525,000 to $600,000 in unexpected tax. All because the replacement was smaller.
The fix: Know the equal-or-up math before you identify replacements. If you're genuinely planning to trade down, accept the boot tax knowingly rather than being surprised by it.
Delaware Statutory Trusts (DSTs) qualify as like-kind replacement under IRC 1031. For LA sellers wanting passive income or stepping down from active management, DSTs are legitimate tools.
They're also sometimes sold by sponsors whose incentives aren't aligned with the buyer's interests. Common DST problems:
The cost: A badly-structured DST can lock a seller into a low-return position for decades. Worse, at end of DST life, the seller may face another 1031 or forced sale under unfavorable conditions.
The fix: Treat DST selection like any other investment. Evaluate sponsor track record, underlying property quality, fee structure, and exit options. The marketing deck is not the investment thesis.
Qualified intermediaries are not federally regulated. Several large QIs have gone insolvent over the last two decades, taking exchange funds with them. When a QI fails mid-exchange, the seller's funds may be frozen or lost. The tax deferral usually also fails.
The cost: Worst case is total loss of sale proceeds plus the tax that would have been deferred. Even in partial-recovery scenarios, legal costs and opportunity cost can run into six figures.
The fix: QI due diligence. Verify:
- Strong balance sheet (well-capitalized, not leveraged)
- Segregated qualified trust accounts (funds not commingled with operating accounts)
- Insurance coverage for client funds
- Long operating history and no regulatory issues
This is not the place to save $500 in QI fees.
The 180-day clock runs from Day 0, regardless of what happens in the 45-day identification window. Common ways to miss Day 180:
The cost: Same as mistake one — full tax on the relinquished sale.
The fix: Target Day 150 for closing, not Day 180. The 30-day buffer absorbs realistic delays.
The 1031 has specific structural requirements:
- Sale proceeds cannot touch the seller's hands
- QI must be engaged before closing the relinquished property
- Exchange documents must be in place at relinquished property closing
- Both properties must be held for investment or business use (not personal residence)
Informal or improper structuring voids the exchange. Common structural errors:
- Sale proceeds deposited to seller's account before QI assignment
- QI engaged after close ("we'll set it up later")
- Replacement property acquired in a different entity than the relinquished property
- Using a related party as QI (prohibited)
The cost: Exchange fails. Full tax on the sale.
The fix: Work with an experienced exchange accommodator from before the sale closes. Ensure all documentation is in place at relinquished property closing.
A 1031 exchange defers tax. It does not eliminate it. The deferred tax rolls into the replacement property's basis and compounds across subsequent 1031s.
However: a 1031-exchanged property held until death receives stepped-up basis at the owner's death. The deferred tax is permanently eliminated for heirs.
For LA multifamily owners over 65 with heirs, this is often the dominant strategic variable. Selling now (without 1031) triggers the full tax. Selling now with 1031 defers. Holding until death eliminates.
The cost of getting this wrong: On a $5M gain with 35% combined tax, failing to recognize the step-up strategy costs heirs $1.75M at estate transfer.
The fix: Estate planning and 1031 strategy have to be coordinated. For older owners, the "best" sale structure often involves hold-until-death rather than sale-and-1031. For younger owners, 1031 with eventual step-up is the strongest multi-decade strategy.
They won't.
No IRS field examiner can grant extensions on 1031 deadlines. No amended return can retroactively qualify a failed exchange. No appeal process addresses procedural timing failures. The 1031 is one of the few tax strategies where compliance is binary and unforgiving.
Sellers who assume "we'll figure it out" when deadlines get tight end up paying the tax.
Every mistake on this list is preventable with 60 days of advance planning. The 1031 exchange is not complicated in its structure. It's unforgiving in its execution. Sellers who understand that distinction execute clean exchanges and preserve the tax deferral. Sellers who don't pay taxes they could have avoided.
Most of the cost of a failed 1031 is borne quietly — six figures here, high six figures there — because failed exchanges don't make the news. They show up on tax returns. The LA multifamily sellers who've done multiple successful 1031s over decades are the ones who made a different set of choices than the sellers who failed one.
Request a free evaluation — including a 1031 strategy review before you commit to a specific sale path →
What is the most common 1031 exchange mistake?
Identification paralysis — arriving at Day 0 without a shortlist of replacement properties. The 45-day clock is unforgiving of preparation gaps.
What happens if my 1031 exchange fails?
The sale becomes fully taxable. Federal capital gains, California state tax, and depreciation recapture all apply. For a typical significant LA multifamily gain, that's 35-40% of the gain in tax.
Can I fix a 1031 structural error after the fact?
Usually not. 1031 compliance is binary. Structural errors made at relinquished property closing typically can't be retroactively cured.
How do I pick a qualified intermediary?
Verify strong capitalization, segregated qualified trust accounts, insurance coverage, and operating history. The cheapest QI is rarely the right QI.
Is a 1031 exchange worth the risk if it might fail?
For a typical LA multifamily sale with significant gain, yes — the deferral is often $500K to $2M. The risk of failure, with proper planning, is low. The risk of not trying is guaranteed tax.
Related reading:
- The Complete 1031 Exchange Guide for LA Multifamily Investors
- 1031 Exchange Timeline — Every Deadline You Cannot Miss
- Try the 1031 Exchange Calculator
Michael Sterman is Senior Managing Director Investments at Marcus & Millichap. $1.41 billion across 254 closed transactions — many involving 1031 exchanges, which means many opportunities to watch these mistakes play out and learn how to prevent them.
Thinking about selling? Get a no-obligation evaluation from a broker with $1.41 billion across 254 closed LA multifamily transactions.
Request Free Evaluation →