Info For Realtors
What is a 1031 Exchange?
A 1031 Exchange allows taxpayers to keep more of their own money working for their benefit by giving them a way to sell their investment property and replace it with more investment property, without having to pay capital gains taxes on the transaction. This is the IRS’ way of saying that as long as all the proper guidelines are followed, a taxpayer selling investment property can use the money they would other wise have paid in capital gains taxes to buy more investment property. This can be done within and between all classes of real property anywhere in the U.S.
Some beneficial uses of 1031 Exchange:
A taxpayer can exchange property that has reached a plateau in value for a property on the upswing. Unproductive land can be exchanged for income-producing property. Management-intensive properties can be exchanged for something more suited to the needs of the taxpayer. Distant properties can be exchanges for others closer to home. A taxpayer can diversify or consolidate real estate holdings geographically or otherwise. Also a taxpayer can exchange a property that has been fully depreciated for more expensive property having more room for deprecation.
What property Qualifies for 1031 Treatment:
The exchanger must hold the relinquished property for investment or for productive use in their trade or business to qualify for 1031 treatment. The Exchanger’s purpose in holding the property, rather than the type of property, in the critical issue. Here are examples of qualifying properties: BARE LAND, COMMERCIAL PROPERTY, INDUSTRIAL PROPERTY, RESIDENTIAL PROPERTY, DOCTOR’S OWN OFFICE. The intent to hold the property for personal use will prevent the property from qualifying for 1031 treatment. Therefore, second homes will not qualify for 1031 treatment unless the property owner changes how they treat or us the second home. For example, a taxpayer could convert their second home to a valid exchange property and establish this intent by properly renting the property and holding it as a legitimate rental property. Consultation with a tax advisor is important whenever a taxpayer changes how they intend to hold property. The intent to hold property “primarily for sale” will prevent the property from qualifying for 1031 treatment. Most properties held by developers, builders and people who perform rehabilitation work are held primarily for sale and may not be the subject of an exchange. When these properties are sold, they are subject to ordinary income taxes rather than capital gain taxes. Partnership interests, notes secured by real property, contract vendors’ interests and foreign property ( under the Revenue Reconciliation Act of 1989) do not qualify for 1031 treatment.
Tax Deferred Exchange Terminology:
As with any other specific area of real estate law, tax deferred exchanges under IRC 1031 have their own language, which may be confusing to those who are unfamiliar with these transactions. The following are some of the used exchange terms and phrases, with their plan English interpretation.
Fair market value of non-qualified property received in an exchange.
A term referring to the control of proceeds by a taxpayer even though funds may not directly be in their possession.
The property owner(s) seeking to defer tax by utilizing an I.R.C. 1031 exchange. ( The internal Revenue code uses the term “taxpayer” )
The property “sold” by the Exchanger. This is also sometimes referred to as the “exchange” property or the “downleg” property.
The property to be acquired by the Exchanger. This is sometimes referred to as the “acquisition” property or the “upleg” property.
This term refers to the nature or character of the property, and not its grade or quality. Generally, real property is “like-kind” as to all other real property, as long as the exchanger’s intent is to hold the properties as an investment or for productive use in a trade or business. With regards to personal property, the definition of “like-kind” is much more restrictive.
The entity that facilitates the exchange for the Exchanger. Some companies use the term “facilitator”, and or “accomodator”. The Treasury Regulations use the term “Qualified Intermediary”.