The Basic Rules for a 1031 Exchange
The Relinquished Property
The Relinquished Property or Properties and the Replacement Property or Properties Must Be Qualifying Property.
Qualifying property is property held for:
investment purposes or
used in a taxpayer’s trade or business.
Investment property includes real estate, improved or unimproved, held for investment or income producing purposes.
Property used in a taxpayer’s trade or business includes office facilities or place of doing business.
Real estate must be replaced with like-kind real estate. This means agricultural real property can be exchanged for residential real or commercial real properties or a combination of real properties. All that matters is that the property give up and the property or properties received must be real property as that term is defined under state law.
Non Qualifying Real Property
Property Which Does Not Qualify For A 1031 Exchange includes:
- A personal residence
- Land under development for resale
- Construction or fix/flips for resale
- Property purchased for resale
- Inventory property
- Corporate stock
- Partnership interests
- LLC membership interests
Replacement Property Title Must Be Taken In The Same Name As The Relinquished Property Was Titled.
If a husband and wife own property in joint tenancy or as tenants in common, the Replacement Property must be deeded to both spouses, either as joint tenants or as tenants in common.
Corporations, partnerships, limited liability companies and trusts must be in title on the Replacement Property the same as they were on the Relinquished Property.
The Replacement Property Must Be Like-Kind
- Improved real estate can be replaced with unimproved real estate.
- Unimproved real estate can be replaced with improved real estate.
- A 100% interest can be exchanged for an undivided percentage interest with multiple owners and vice versa.
- One property can be exchanged for two or more properties.
- Two or more properties can be exchanged for one Replacement Property.
- A duplex can be exchanged for a four-plex.
- Investment property can be exchanged for business property and vice versa.
- Agricultural property can be exchanged for commercial and/or residential property and vice versa
As referenced above, a taxpayer’s personal residence cannot be exchanged for income property and income or investment property cannot be exchanged for a personal residence which the taxpayer will reside in. However, in some circumstances, vacation property can qualify if certain conditions are met. Seek professional advice from us before going that route.
Boot Received In Addition To Like-kind Replacement Property Will Be Taxable (to the extent of gain realized on the exchange). This is acceptable when a seller desires some cash or debt reduction and is willing to pay taxes. Otherwise, boot should be avoided in order for a 1031 Exchange to be completely tax free.
The term “boot” is not used in the Internal Revenue Code or the Regulations. But, it is commonly used in discussing the tax consequences of a Section 1031 tax-deferred exchange.
Boot received is the money, debt relief or the fair market value of “other property” received by the taxpayer in an exchange.
Money includes all cash equivalents received by the taxpayer.
Debt relief is any net debt reduction which occurs as a result of the exchange taking into account the debt on the Relinquished Property and the Replacement Property.
“Other property” is property that is non-like-kind, such as personal property received in an exchange of real property, property used for personal purposes, or “non-qualified property.” “Other property” also includes such things as a promissory note received from a buyer (Seller Financing).
A Rule Of Thumb for avoiding “boot” is to always replace with property of equal or greater value than the Relinquished Property. Never “trade down.” Trading down always results in boot received, either cash, debt reduction or both. Boot received is mitigated by exchange expenses paid.