Since 1921, the rules for qualifying and completing 1031 exchanges have gradually broadened and become less restrictive. Even so, there are dos and don'ts and several gray areas of which taxpayers should be aware. For the taxable gain to be deferred, specific key requirements must be satisfied.
- There Must Be No Constructive or Having direct access to exchange funds or other property. Actual receipt of exchange funds during the exchange period is cause for disqualification of the tax deferred exchange. Compare to Constructive Receipt, below. Actual Receipt of Exchange Funds
- The transfer of the relinquished property to the Qualified Intermediary, and the receipt of the replacement property from the Qualified Intermediary is considered an exchange. To be compliant with IRC Section 1031, the transaction must be properly structured, rather than being a sale to one party followed by a purchase from another party. Exchange Must Be Equal or Up in Value
- Must Follow The transfer of the relinquished property to the Qualified Intermediary, and the receipt of the replacement property from the Qualified Intermediary is considered an exchange. To be compliant with IRC Section 1031, the transaction must be properly structured, rather than being a sale to one party followed by a purchase from another party. Exchange Time Limit & Identification Requirement
- Properties Must Be Held for Business or Investment Purposes
- Properties Must Be The transfer of the relinquished property to the Qualified Intermediary, and the receipt of the replacement property from the Qualified Intermediary is considered an exchange. To be compliant with IRC Section 1031, the transaction must be properly structured, rather than being a sale to one party followed by a purchase from another party. Exchange d
- Properties Must be " Refers to the "nature or character" of the property and not to its "grade or quality." That is, real property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other real property. Personal property held for investment or the productive use in a trade or business may generally be exchanged on a tax-deferred basis for other personal property, provided the personal property is of "like kind" or "like class." Professional tax advice should be obtained when planning exchanges. Like-Kind ": Two real estate assets of a similar nature irrespective of class or quality, that (if exchanged by the rules) can be replaced without realizing any taxable gain.
Defining Like-Kind Requirements
There are many requirements to ensure a compliant 1031 exchange. Potential exchangers frequently pose questions on what property is considered "like-kind" to another property. Generally, any type of genuine property interest is like‐kind to any other type of real property. The properties do not have to be of the same nature. For example, an exchanger could exchange a single-family home held as a rental property for a vacant parcel of land purchased as an investment. Section 1031 defines like-kind property as any property owned for investment or use in a trade or business. The relinquished property and the replacement must be of like-kind to qualify for exchange treatment.
Examples of Property that are not Like-Kind
In simple terms, the taxpayer must use both properties involved in exchange for trade, business, or investment purposes. So, for example, although a personal residence or a vacation home is real estate, it would not qualify for exchange treatment since it is held for personal use and not for investment. Property owned as part of a dealer's or developer's inventory also does not qualify. The rules provide that the words "like-kind" reference the nature or character of the property and not its class or quality. Under regulations, things to consider are "the respective interests in the physical properties, the nature of the title conveyed, the rights of the parties, and the duration of the interests."
Based on these provisions, like-kind is defined in the tax code quite liberally in that any real estate is like-kind to any other type of real estate. For example, whether the real estate is improved or unimproved is not significant. Many court cases and rulings have addressed the like-kind standard for real property. Regulations provide examples of like-kind real property, some of which are obvious, others less so. Below are examples of real property interests that one can exchange for any other type of real estate:
- Strip center for multi-family rental
- Vacant lot for improved property
- Improvements on property not already owned
- Oil, gas and other mineral interests
- Water rights
- Cell tower, billboard and fiber optic cable easements
- Conservation easements
The Regulations require the replacement property to be located within the United States (and some territories) and qualify as like-kind for the property sold in the United States. For example, a taxpayer cannot use proceeds from an office building in Dallas to acquire an investment property in Mexico. While a Mexican condominium investment sounds like a great retirement plan, after the extended rental period is over it's not going to pass muster with the IRS when it comes to Section 1031. Property located outside the United States is like-kind only to other property located outside of the United States.
- Like-kind real estate are assets of the exact nature or character, irrespective of class or quality, one can exchange that without realizing tax liability under Section 1031
- Properties must be held for use in a trade or business, or investment purposes, but do not need to be similar in class or quality
- Any type of real estate is like-kind to any other real estate interest
- Many non-traditional real estate interests are like-kind to conventional interests
- Properties must be in the United States (and some US territories and possessions) to qualify as like-kind to other properties in the United States
Be sure to discuss 1031 exchange plans with a trusted Qualified A person acting to facilitate an exchange under section 1031 and the regulations. This person may not be the taxpayer or a disqualified person. Section 1.1031(k)-1(g)(4)(iii) requires that, for an intermediary to be a qualified intermediary, the intermediary must enter into a written "exchange" agreement with the taxpayer and, as required by the exchange agreement, acquire the relinquished property from the taxpayer, transfer the relinquished property, acquire the replacement property, and transfer the replacement property to the taxpayer. Intermediary . Following the like-kind requirements is just one of several rules that must be adhered to in order to complete a successful 1031 exchange.