Understanding the 1031 exchange rules is critical for those in the farming business, own business aircraft, an apartment complex, single family investment, land, or who own in any type of business equipment, the chances are that there will come a point in time when a decision will be made to exchange or upgrade company assets. Business owners and CEOs who find themselves in this position should consider a 1031 exchange instead of a traditional sale the next time they prepare for such an acquisition because under these conditions, they will be able to complete the sale while at the same time, defer the 25 percent recaptured depreciation tax that will have been triggered on the sale. While the idea of such a transaction offers clear benefits, there are certain 1031 exchange rules which must be followed in order to keep the process smooth while keeping it out of the crosshairs of the IRS.
180 Calendar Day Timeline
The first and broadest of 1031 exchange rules is the fact that the transaction must come to a close within 180 days after it begins. This is important to note because contrary to what some believe, the sale and acquisition portions of a 1031 exchange do not need to take place simultaneously. In fact, the bulk of 1031 exchanges today are closed upon as delayed exchanges and the small portion that are executed simultaneously are rarely done so without a qualified intermediary agreement having been put in place beforehand. However, it is also important to note that during a delayed exchange, a prospective replacement for property or equipment must be identified within 45 days from the initial relinquishment, or the entire transaction could be nullified.
While it is important to understand the 1031 exchange rules that govern time frames within which transactions are to be made, it is even more crucial to understand the guidelines and regulations surrounding the types of property and equipment that can be designated under a 1031 exchange. For instance, properties sold and acquired must held either for productive business use or in the process of being readied for such purposes. In other words, one cannot exchange a commercial property for property held primarily for personal reasons.
Like Kind 1031 Exchange Rule
One of the most important 1031 exchange rules to observe when exchanging property is the “like kind” rule. Under this principle, the rules tend to be somewhat flexible when exchanging different types of real property. For instance, vacant land being sold for a plot containing a commercial building being acquired would be acceptable including a property with land can be exchanged for properties that do not have land such as an apartment coop in a high rise building. Another rule involving like kind exchanges is that domestic US property cannot be exchanged with any located outside the US.
The 1031 exchange rules for equipment can often be a bit more restrictive, especially under the like kind rule. As an example, someone who owns a rental car fleet cannot exchange any cars for trucks. In addition, a business owner who operates both a construction and landscaping business could not exchange a front loader for a crane.
Lastly, it is important that you know the types of property that are barred from the process based on 1031 exchange rules. These types of properties include indebtedness, primary residence, inventory, stocks, notes, bonds, partnership interests, certificates of trust, and other securities. By understanding what types of property and equipment can be exchanged as well as how the process works, both individual and corporate, resident and non-resident taxpayers would be able to take full advantage of this tax deferral practice and the tax benefits that come with the 1031 exchange.
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