IRC Section 1031 Exchange Qualified Use Requirements

Does your property meet the productive use or qualified use requirement for a 1031 exchange? Here are examples of those that do and do not.
1031 Exchange Productive Use or Qualified Use Rules

We recently examined the duration a taxpayer must hold a relinquished and replacement property to satisfy the requirement that exchanged assets must be held for investment or used in a business or trade.  The conclusion was that there is no specific time limit for an asset to be deemed to having been held, rather it is a facts and circumstances test.  In this post, we will look into the issue of “qualified use” as another key element in a successful tax deferred exchange.

IRC Section 1031(a)(1) provides “In general no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment”. 

Let’s look at some examples where the productive or qualified use requirement may, or may not, apply in a 1031 exchange.

Vacation Homes and Qualified Use

A taxpayer’s vacation home or second residence can be eligible for a 1031 exchange if specific requirements are met. The property must have been held for investment for at least 24 months prior to the exchange. Additionally, the property must have been rented out at fair market value for a minimum of 14 days within each of the 12 months and the taxpayer cannot have used the property personally for more than 14 days, or 10% of the days the property was rented, within each of the 12 month periods. 

Taxpayer Occupied Multi-Family Property and Qualified Use

A multifamily property such as a two flat or three flat, where the owner lives in one unit and rents out the other unit(s) can be the subject of an exchange of the investment portion.  The sale would be split where the taxpayer could receive directly the net proceeds pertaining to the personal use unit and could cause the net proceeds pertaining to the investment unit(s) to go to fund the exchange account. In most cases, the gain associated with the owner occupied unit could also be deferred under IRC Section 121, the Code section dealing with the sale of a personal residence. 

Keep in mind that the assignment of contract rights under the relinquished property agreement must be modified to show what percentage interest of the whole property will be the subject of the assignment to the qualified intermediary.

Taxpayer Occupied Farm Land and Qualified Use

Similarly, exchanges of farmland are very common.  Often the personal residence of the owner sits on the farmland.  Again, as in the other examples, the percentage of the land that is used for farming can be exchanged and the percentage used for the dwelling can be sheltered under IRC Section 121.

Mixed Use Personal Residences and Qualified Use

There are taxpayers who have mixed use of their personal residence.  An example of this might be a psychologist who uses a room in the home as the office to meet with clients.  If the square footage of this room is 10% of the entire residence than a 10% interest in the relinquished property could be sold as part of an exchange. 

Death of a Taxpayer and Qualified Use

As the saying goes, the only sure things in life are death and taxes.  We have covered taxes above, so let’s look at the effect of the death of the taxpayer on the issue of qualified use.  If a taxpayer dies prior to the anticipated sale of relinquished property, the heirs get the property with a stepped up basis and would not have a need for tax deferral.  However in the event a taxpayer dies after the start of an exchange and the sale of the relinquished property, the gain would be due without an acquisition of replacement property.  Despite the estate not having qualified use of the property itself, there are various favorable IRS rulings allowing the estate to acquire the replacement property and defer the gain recognition.


The exchange rules require that the relinquished and replacement properties be ones that are held for productive use in a business or trade or as an investment. This “productive use,” often referred to ‘qualified use” can sometimes cause confusion where there is both a personal use of a property and also a qualified use of part of the same property.  In most cases, the qualified use portion of the property can be separated and be the subject of a §1031 exchange.


Updated 4/12/2022.