As an increasing number of individuals and entities look for tax deferral strategies, the broad scope of property types available for 1031 exchange treatment continues to attract growing interest. In many ways, there is a property type that is suited for each Exchangor’s needs. While most familiar with Like Kind Exchange are aware that residential and commercial real property are qualified, it is less known that Delaware Statutory Trusts or Oil, Gas and Mineral rights are eligible as well. Whether you are interested in being active in your investment as a landlord or property manager or you are looking for opportunities for passive income, there are a plethora of options to consider.
One of the key misconceptions around a 1031 exchange or Like Kind Exchange is that the property type you sell must be the same property type you acquire. If you were to sell an apartment complex, you have access to any of the types listed below, as long as your intent for the property was to hold it for trade, business or investment purposes. Keep in mind that you can also combine multiple property types in a single exchange as long as the value of your net sales proceeds enabled you to do so.
The following list of 1031 exchange property types is an excellent place to start when considering what your next step will be after you sell your relinquished property:
- Residential Property
- Commercial Property
- Vacation Rental Property
- Agriculture Property
- Conservation Property
- Timberland Investment Property
- International Property
- Oil, Gas, Mineral, Water and Ditch Rights
- Delaware Statutory Trust, NNN and Tenant in Common Interests
Residential 1031 Exchange Property
The most common type of property utilized in Like Kind Exchanges, Residential Property ranges from single family homes to apartment complexes. As investors build their portfolio of holdings, a 1031 exchange can enable rapid advancement through increased cash flow, renewed depreciation schedules and greater purchasing power due to the capital available through tax deferral. Consider also the advantage of a mixed-use strategy and utilize 1031 exchange treatment towards a duplex or quadplex while also living on the property. Many compelling options exist, and each provides unique benefits.
Commercial 1031 Exchange Property
Commercial properties will have an improved structure to be depreciated and typically include land. Both may appreciate in value enough to trigger a gain at the time of the sale. Both the recaptured depreciation and gain result in a tax that can be deferred in a 1031 commercial property exchange. Below is a list of potential commercial property types that are eligible for 1031 exchange treatment:
- Apartments
- Convenience stores and gas stations
- Golf courses and practice ranges
- Hotels and motels
- Marinas
- Nursing homes
- Office Buildings
- Parking garages and lots
- Self storage units
- Shopping centers and strip malls
- Warehouses
Vacation Rental 1031 Exchange Property
1031 exchange eligible vacation rental properties range from homes, rental and condominiums along the coast to lake cottages and condominiums inland. They each provide the investor with an opportunity to hold the property as an investment for appreciation, deducting yearly expenses and depreciation. Personal use for 1031 exchange vacation homes must be no greater than 14 overnights or 10 percent of the days rented per year. The IRS provided these guidelines as a bright line test for vacation property owners and their professional advisors. Vacation properties can be exchanged in less than the periods stated in the IRS Rev. Proc. 2008-16 but could be subject to IRS review.
Agriculture 1031 Exchange Property
Farmers and ranchers engage in 1031 exchanges for reasons of diversification, consolidation, relocation, appreciation and replacing with less labor intensive cash flow properties than agriculture. Once the often difficult decision to sell has been made, the question is what to do next? What are the tax implications? How will this impact my children? Given your goals, perhaps it may be best for estate planning purposes to diversify the ranch or agriculture based properties into properties that can be eventually gifted to the taxpayer’s heirs.
Alternatively, you may find it beneficial to consolidate multiple land tracts into one larger property. If the taxpayer is moving, relocating a property may be the right choice. If the farm or ranch sales value has peaked, reinvesting into property in the path of progress for better appreciation is the right alternative. Finally, a less labor intensive cash flowing property can provide the passive income sought to supplement retirement while maintaining an investment property for the taxpayer’s beneficiaries.
Conservation Easement 1031 Exchange Property
The use of conservation easements and land trusts have grown steadily since the 1970s, in many cases permanently preserving millions of acres for wildlife conservation, forestry and wetlands from urban sprawl. Land conservation and easement conservation are created when the property owner transfers some or all rights to a qualified conservation non-governmental organization or government entity for a specific time or perpetuity. The utility, government or conservation entity as the owner of the easement has the legal right to prohibit development contrary to the easement agreement that establishes the restrictions specific to the piece of land.
The benefit to the property owner is that they maintain title to the land, enjoy limited use that does not interfere with the easement and have preserved the property’s natural habitat. As with any property right, easements may be donated or sold. Donating land to a charitable organization may be eligible for charitable income tax deductions for the value of the contributed easement.
Timberland Investment 1031 Exchange Property
Perpetual timber rights to harvest unlimited standing timber are similar to water and mineral rights classified as real property rights given state law. A deed for timber must be conveyed, not a contract and bill of sale. There cannot be a pre-established cutting contract or the timber can be considered personal property which is not “like kind” to real property. In many states it is possible to separate the timber interest from the title to the land. A timber deed and a land deed can be exchanged independently for a simple fee interest in real property. A 1031 exchange allows the conversion of a timber deed to real property while retaining ownership of the original land.
Thirty-year leasehold timber rights, including the right to extract timber or an outright grant of timber rights, can be exchanged for other real property. Each 1031 exchange must be reviewed on a case-by-case basis.
International 1031 Exchange Property
The same 1031 exchange rules for US based real and personal property exchanges apply to exchanges of internationally held property for like kind international property. However, property held in the US is not considered like kind with property held predominantly outside the US. As long as a non-citizen has an Individual Taxpayer Identification Number (ITIN), they can benefit from the advantages found with a 1031 exchange.
The challenge is to hold the exchange funds or net equity locally versus converting to US Dollars, wiring to a US bank and converting back to sovereign currency. Given the escrow account or disbursement authorization procedure satisfies the (g)6) constructive receipt requirements of the 1031 code, the exchange proceeds can be held locally. Additionally, the use of a qualified escrow account agreement that requires dual signatures for disbursement, one from the client and one from Atlas 1031 Exchange, assures that funds cannot be moved without the client’s signature.
In International 1031 exchanges, establishing a “Bank Advocate” is essential. This individual must still meet the “related party” requirements and cannot be of ascending or descending family lines; a cousin, aunt or brother-in-law would be eligible. Though eligible for 1031 exchange treatment, international exchanges are far more complex than domestic exchanges. If you’re considering an exchange of this nature please contact Atlas 1031 Exchange as early as possible to begin the qualifying process.
Oil, Gas, Mineral, Water and Ditch Rights
Interest in oil, gas and mineral estates, in addition to water and ditch rights, qualify for 1031 exchange tax deferrals given the existence of a perpetual interest. Leases, royalties and production payments are often how the perpetual interests are conveyed.
For federal tax purposes, mineral leases are considered a real property interest and eligible for 1031 tax deferred treatment. Leases provide the lessee with the right to remove minerals for a specific period of time or until depletion along with incurring the costs of discovery and removal. Leases are also known as a working or an operating interest. The lessee may deduct the intangible drilling costs (IDCs) for removing the mineral. IDCs include labor, repair and maintenance, fuel, transportation, supplies and other related production expenses.
For federal tax purposes, royalties are considered a real property interest and qualify for 1031 exchange tax deferral treatment. Oil, gas or mineral royalties do not represent an operating interest, and neither incur nor are responsible for production costs. Instead, the holder of the royalty receives a percentage interest in the materials removed for the life of the property.
Production payments are not eligible for 1031 exchanges given they are a right to the oil, gas or mineral at a specific value, produced and paid from a percentage of removed minerals. Unlike royalties, production payments are finite based upon a specified production versus royalties that are perpetual or until the mineral is exhausted.
Delaware Statutory Trusts and Tenant in Common Interests
Tenants in Common 1031 exchanges allow property owners to defer capital gains when replacing a fractional interest in a cash flowing property. It is a form of direct ownership that is not affected by the IRC §1031(a)(2)(D) exclusion as long as the co-tenants or owners are not treated as partners for income tax purposes. Tenant In Common Interests, also known as a TIC, is one way that an investor can take part in ownership of a property that they would potentially not be able to afford on their own, such as a portion of commercial strip mall or building leased to Walgreens.
It is important to note that most TIC investments require the “Accredited” Investor status, meaning that your net worth exceeds $1,000,000 (excluding your personal residence) and your income exceeds $200,000 in each of the last two years or if you are investing jointly with your spouse, your income must exceed $300,000. Though they differ from Delaware Statutory Trusts, they share many commonalities.
In 2004, the IRS released Rev. Rul. 2004-86 which allowed Delaware Statutory Trusts to acquire real estate where the beneficial interest is treated as direct interests. This allowed for the utilization of Delaware Statutory Trusts (DST) to qualify for 1031 exchange treatment. DST’s differ from TIC’s as they have no voting authority but also do not require the forming of a single member LLC to participate. The number of investors is unlimited and determined by the structure of the DST, whereas a TIC is limited to up to 35 investors.
There are a bevy of options that include special interest DSTs that focus on health care, senior living or retail properties. The key advantage to a TIC or DST interest as replacement property is their passive nature. They are terrific options if you have additional net sales proceeds to invest after identifying other property or if you are seeking a passive investment.
We Can Help!
If you are considering a 1031 exchange involving any property type, Atlas 1031 provides accommodation services compliant with Internal Revenue Code Section 1031. Click below to begin a consultation or call our office at 1 800 227 1031 to discuss your 1031 exchange.
