Section 1031 of the Internal Revenue Code provides for the postponement of the tax liability for the gain in the sale of investment and business property. Under Section 1031 you can sell an investment or business property without paying tax for any gain resulting from the sale, provided you exchange the property being sold for a like-kind property of equal or greater value than the one you are selling. The gain deferred under a Section 1031 exchange of like-kind properties is tax-deferred, not tax-free.
If you exchange a property of less value than the one you are selling, then tax will be due for the portion of the sale not included in the exchange. For example, you sell a property for $500,000.00 and you acquire another property for $400,000.00; the gain for $400,000.00 will be deferred and the gain for $100,000.00 will be taxable. On the other hand, if you exchange a property of equal or greater value than the one you are selling, all gain will be deferred. For example you exchange a property of $375,000.00 for a property of $450,000.00, all tax on the gain will be deferred. As seen from these examples, the exchange can include only like-kind properties or it can include like-kind properties along with cash to complete the exchange.
For a transaction to qualify as a Section 1031 deferred exchange, the disposition of the property being sold, or relinquished property, and the acquisition of the purchased property, or replacement property, must take place as mutually dependent parts of an integrated transaction, or exchange of property, under the guidance and control of an exchange agreement with an independent exchange facilitator.
Not all properties qualify for a Section 1031 exchange. Properties used for personal use, such as a primary residence, or a second home, or a vacation home, do not qualify for an exchange. Both properties, must be held as investment properties, or must be used in a trade or business. Both properties must be similar enough to qualify as “like-kind”. They must be of the same nature, character or class. It is important to note that the IRS considers most investment real estate to be like-kind to other investment real estate. For example a rental single-family residence is considered like-kind to vacant land.
The 1031 exchange does not require a simultaneous swap of properties. Instead the exchange allows 45 days after the date of the sale of the relinquished property to identify one or more potential replacement properties. The identification must be clearly identified in writing and normally delivered to the intermediary. Delivery of the notice to your attorney, real estate agent, accountant or other persons acting as your agents is not allowed. The closing of the purchase of the identified replacement property or properties must take place within 180 days from the date of the sale of the relinquished property. In the event that the due date, or extensions thereof, of the income tax return for the tax year in which the relinquished property was sold is less than 180 days from the date of sale of the relinquished property, then the replacement property must be closed before the due date for these taxes, even if it is less than 180 days from the date of sale.
At the present time there is no limit as to the value of the properties involved in a 1031 exchange. However, section 1031 of the Internal Revenue Code is now under review in Congress and it is probable that the value of properties in the exchange will be limited in the future.
Please contact our office for an appointment if you are contemplating the sale of a property and its subsequent exchange for a replacement property.