Part 1 - 1031 Exchanges
A 1031 exchange refers to section 1031 in the US Internal Revenue Code which allows you to avoid paying capital gains tax when you sell business or investment property and exchange it for property that is “like-kind” in the eyes of the IRS.
2021 was the 100 year anniversary of 1031 exchanges.
In 2018 The Tax Cuts and Jobs Act amended code 1031 by changing the word “property” to “real property”. This means that like-kind exchanges remain alive for real property (land, ranch, house, condo, etc), but are disallowed for personal property (furniture, farm equipment, private jets, etc).
Popular Uses for Property Investors
Those who wish to upgrade to a larger investment property without taking a tax hit when selling their smaller property.
Those who wish to sell an investment property in 1 market and purchase 1 located elsewhere
Investment Properties Include
Businesses such as stores, manufacturing facilities, or an office building
Investment Properties
Homes that are actively being rented
Land Investments
Large Ranches
Leasehold 30+ years
Other
Water and Mineral Rights
Communication Easement - must be on title
Conservation easements
Easements for right of way
Fractional Ownership - must be on title
“Like-kind” exchanges are more broad than you might think. For instance unimproved real property can be exchanged for improved real property and residences can be exchanged for commercial.
What Does NOT Qualify for a 1031 Exchange?
Personal Residence - primary or secondary
Property intended for resale - spec homes, fix & flips, dealer inventory, condo conversions
Other securities or other forms of indebtedness or interest
Stocks, bonds, and notes
Partnership Interests (there is 1 exception)
Properties located outside of the United States
Deciphering between a property being a second home or an investment property can be tricky, especially when that property is in a resort area. There are a few things that can help determine this.
In the last two, 12 month periods was the property rented for 14 days or more during each 12 month period
Was it rented for fair market value?
Did the taxpayer limit their use to 14 or fewer days during each of the two, 12 month periods?
If you answered “Yes” to the above 3 questions changes are that your property could be considered an investment property and considered for a 1031 exchange if it also meets the other requirements below.
Other 1031 Requirements
Your intent of the property must be for investment
CPAs like ownership for 1 yr plus 1 day and the IRS likes 2 or more years. 2 or more years is always the safer bet.
If it can be rented it must be rented
Can be short to long term
You must at least try to rent it. Land is the exception. Land is almost always eligible for a 1031
There are strict rules that must be followed in order for a 1031 exchange to qualify. It is imperative that you complete the exchange correctly to avoid a huge tax bill from the IRS.
This is Part 1 of a 5 part series addressing 1031 exchanges. Please visit my other blogs for more information on 1031 Exchanges:
Part 2 - 1031 Exchange Process
Part 3 - 1031 Exchange Rules
Part 4 - Types of 1031 Exchanges
Part 5 - Advantages of 1031 Exchanges
If you are considering selling an investment property I highly recommend you speak to your financial advisor about the possible benefits a 1031 exchange could have for you. It’s also important to note that I am a real estate agent and not an accountant, a QI, or an attorney. Please seek legal and financial advice from those who are qualified.
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