The 1031 tax deferred exchange is essentially trading one property for another to potentially defer
(delay) the federal income tax - capital gains due upon sale of the property. It could be considered an interest free
loan from the government. Even if you sell this property in the future but continue to exchange
(equal or higher values) then the tax can continue to be deferred. At the death of the taxpayer,
the capital gain debt is forgiven.
There are four types of exchanges:
 |
-Simultaneous |
-Delayed |
-Multi-Property / Multi Party |
-Reverse |
And a few simple
Key definitions:
It is recommended that the taxpayer consult with their accountant prior to starting the 1031 exchange
process to review all of your possibilities regarding the sale of their property and the capital gains
that may become due on the sale of said property.
Some issues to review are:
How long has the taxpayer owned the property they are selling and how was it handled on their previous tax records.
Was it a primary residence, vacation home or rental?
Will the taxpayer use this property as a primary residence?
The 1031 exchange is not for this purpose as the taxpayer may only use the property 14 days out of the year. If the taxpayer plans to rent the property for a year or longer and then changes their mind and decides to use the exchange property as a primary residence this is a possibility see below*.
How much capital gains debt will the taxpayer realize?
The taxpayer will need to counter the cost of the exchange with the tax due.
Will the taxpayers exchange property purchase price equal or exceed the value of their sale?
It is necessary to invest equal or greater value or there will be some capital tax realized on the transaction. The basic rule of thumb is that it is necessary that the taxpayer reinvests any mortgage debt plus any cash realized on the sale minus closing commissions and doc stamps.
How long does the taxpayer plan to hold on to their property prior to resale?
The premise of the 1031 exchange is not for quick turnover, we recommend a one year holding period, although there is not statutory or case law.
* If the taxpayer purchases property in an exchange and than after one year converts this property to their primary residence, it will be necessary for the taxpayer to live in the property for over five years to exclude capital gains on a primary residence exclusion rule.
Does the taxpayer plan on taking any cash from the sale (Boot)?
Cash received directly to the client at any point will be considered Boot and taxed as capital gains by the IRS.
Does the taxpayer plan on using any funds for improvements on their replacement property?
Rule of thumb for improvements would be permanent fixtures to the property, ex: roof, deck, tile.
Does the taxpayer plan on buying property and building a house?
All funds must be dispersed from the exchange account and the deed to the property must pass to the taxpayer prior to the 180 days to be considered for the 1031 exchange.
Where is the property located?
The relinquished and replacement properties must be in the United States of America.
In a 1031 exchange transaction like kind property simply means one type of real estate can be exchanged
for another type of real estate and personal property can be exchanged for other similar personal property.
Not all 1031 exchanges are limited to the real estate venue.
Most 1031 exchanges deal with qualified real property, which is property used for investments purposes
or in a trade or business. Real property is considered improved or unimproved real estate. This can include
vacant land, single-family residence, duplex, motel, tenants in common (TIC), office building, warehouse
etc. Any of these can be combined to do a like kind property exchange.
Example:
Exchanger sells a duplex and then buys vacant land and a single-family residence.
Personal Residence
If you have not sold your primary residence in the past five years and have lived in the residence for two years then there are other credits allowed relieving some capital gain tax. This is best to discuss directly with your accountant.
Property purchased for flip or resale
The IRS has no specific guidance on how long a property must be kept to qualify but it is recommended that the property should be rented or held for one complete tax year.
| Corporation common stock |
Notes or Bonds |
| Partnership interests |
Land under development |
| Multi-member Limited Liability Company |
Personal property like kind is more restrictive; some examples of personal property would be automobiles, aircraft, office equipment, computers, copyrights, oil and gas drilling equipment.
