Over the past 17 years, we have had the pleasure of guiding thousands of Exchangors through the 1031 Exchange process. Our Blog draws from that experience and includes content ranging from the basics of an Exchange for first time Exchangors to detailed commentary on complex exchanges for the expert investor. If you do not find the topic or specific question you are looking for, reach out to us via email at info@atlas1031.com or call our office to speak with our team at 1 800 227 1031.
A 1031 exchange is a wealth building strategy known as Internal Revenue Code Section 1.1031. It is used by corporations, individuals, trusts and partnerships both domestic and foreign, for the exchange of real and personal property held in the productive use of a business or for investment. With each 1031 exchange is a timeline requiring strict adherence.
For those not familiar with 1031 exchanges, the definition and application of like-kind requires an explanation to fully appreciate the breadth and depth. 1031 like-kind exchanges were first legislated as part of the National Revenue Act of 1921. 1031 exchanges were created under the premise that when a taxpayer reinvests the sale proceeds into another like-kind property, the economic gain has not been realized (creating the funds to pay the capital gains tax). The taxpayer’s economic position is the same, only the property has changed, as in land for an investment rental property. Consequently, to pay the tax when the replacement property of equal or greater value is acquired is unfair. Rather, when the replacement property is sold, the deferred gain from the original property plus any additional gain realized since the purchase of the replacement property is subject to tax. If another 1031 exchange is initiated, the tax is deferred.
The 1031 exchange code states that no gain or loss shall be recognized on the exchange of property held for productive use in trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held for productive use in trade or business or for investment. Property held in the United States is considered like-kind with property held in the United States, while property held internationally is like-kind with property held internationally.
State laws also determine whether a property is considered real or personal as is the case of water rights and options. Does the state consider mobile homes in a mobile home park personal or real property?
In a 1031 exchange, the real property application is broad, allowing real property to be exchanged for any real property. Real property exchanges consider factors including “the respective interests in the physical properties, the nature of the title conveyed, the rights of the parties, and the duration of the interests” per Koch v. Commissioner of Internal Revenue, 1978. Examples of real property exchanges include:
What is not eligible for 1031 consideration is:
Understanding what property is eligible for a 1031 exchange is one of the first steps to understanding the value of 1031 exchanges. For a complimentary eBook on “Ten Reasons Why a 1031 Makes Sense,” click here to receive your copy instantaneously.
A 1031 exchange represents a solid strategy for deferring the capital gains and recaptured depreciation taxes when selling and replacing like-kind, real and personal property held for productive use in a trade, business or for investment. These tax deferrals, along with asset liquidity, are the core benefits of the 1031 exchange.
Reverse 1031 exchanges were officially recognized with Revenue Procedure 2000-37, providing a safe harbor for the Exchange Accommodator Titleholder (EAT) to park either the relinquished (old) or replacement property for up to 180 calendar days. Prior to this milestone, 1031 exchanges were either forward or simultaneous exchanges where the old property is closed before the new property is acquired. Simultaneous 1031 exchanges are those where the old and new properties are exchanged at one closing. Reverses provided flexibility to acquire the new property before selling the old.
1031 exchange rules apply to Internal Revenue Code Section 1031 tax deferred exchanges. A 1031 exchange allows resident or non-resident United States federal taxpayers to defer capital gains and recaptured deprecation taxes when exchanging real or personal property held for productive use in a trade, business or for investment for like-kind real or personal property held for productive use in a trade, business or for investment. The tax otherwise paid in a traditional sale is deferred indefinitely until the replacement property is sold or another 1031 exchange is initiated.
The benefits of a 1031 exchange have been well-documented by CPAs and financial advisors as a wealth building strategy for individuals, trusts, partnerships and corporations — both United States residents and non-resident foreigners. The core of the strategy is the deferred federal, state and recaptured depreciation taxes, enabling the taxpayer to cash in on, an indefinite interest free loan given like-kind replacement property of equal or greater value is acquired and strict 1031 exchange rules are followed.