Understanding a 1031 Tax Deferred Exchange of Real Estate: Part I
By Martin S. Edwards, Vice President & General Counsel, President North Star Deferred Exchange LLC
The concept of a 1031 tax-deferred exchange is quite simple: If one trades property for like-kindlike-kind
property and does not receive any cash or other non-like-kind property, then no gain has been recognized, and there are no immediate tax consequences. While the basisbasis
in the replacement propertyreplacement property
is affected, any gain is deferred until the eventual sale of the replacement property. Subsequent exchanges can continue to defer additional gain. Tax-deferred or Like-Kind Exchanges (LKE) of real estate and personal property have been recognized by the I.R.C. since the 1920's, however it was not until a landmark legal decision came out in the early 1980's that marked the advent of exchanging today.
It was not until the landmark decision in the case of Starker v. U.S. (602F.2d 1341 (9th Cir. 1979)) that an exchange became practical for everyday transactions. As a result of the Starker decision, it became possible to accomplish a valid exchange on a non-simultaneous basis and to effectively trade with a person other then the taxpayertaxpayer
's buyerbuyer
. Prior to that time, to accomplish an exchange, a taxpayer had to locate a replacement property in advance and prepare to close the sale of the primary property and replacement property as part of a single complicated escrowescrow
.
The I.R.C. § 1031 rules apply only to like-kind exchanges of property "held for productive use in trade or business or for investment." Owner-occupied residential property, vacation homes and property held as inventory for sale do not qualify. Also excluded are stocks, bonds, securities, partnership interests, and certificates of trust or beneficial interestinterest
. IN the case of real estate exchanges, the like-kind standard is usually easy to satisfy. Generally, any type of real 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, a single-family home held as rental property could be exchanged for a vacant parcel of land purchased as an investment. Similarly, a leasehold interest of 30 or more years could be exchanged for a strip shopping center, and the sale of a fee interest in real estate can be exchanged for a purchaser's interest under an installment agreement for deed. Even the transfer of a fee interest in real estate is like-kind to certain non-fee interests in real estate such as long-term leases, purchases under an installment agreement, easements and water rights.
Look for Part II of this article in our next newsletter, which will address the identificationidentification
of replacement property
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