Section 1031 of the Internal Revenue Code affords a number of potential benefits for property owners – primarily the ability to defer taxes when swapping a relinquished property with a qualifying replacement. Often referred to as a ‘1031 Exchange’, the following criteria must be met in order to receive 100% tax deferral.
- The properties being exchanged must be for trade/business or investment purposes, not for personal use.
- They must be considered ‘real like-kind property’, but that definition is fairly broad. It can include ranch and farm land, rent houses, office buildings, residential or commercial lots, conservation easements, water or mineral rights, and more.
- The purchase price of the replacement property must be greater than or equal to the sale price of the relinquished property.
- You must not receive cash at closing.
- An intermediary must hold proceeds from the sale of the relinquished property, so they are not actually or constructively received by you before the purchase of the replacement property.
- The replacement property must be acquired with the intent to hold, so material changes to the arrangement within a year or two would raise a red flag.
- You cannot purchase replacement property from a related party, such as a family member or controlled corporation, partnership, or trust.
- The title owner of the replacement property must be identical to that of the relinquished property.
Keep in mind that if any ‘unlike-kind property’ is included in a transaction – such as office furniture in an acquired building – you will pay taxes on its fair market value. And even a tax-deferred exchange of real like-kind property must be reported to the IRS on your Federal income tax return.
1031 Exchanges can be a bit complicated – but they can also be a great opportunity. Be sure to consult with your tax advisor for more details that could apply to your unique situation.