Like-Kind Exchange 1031 software is used by companies that routinely sell and replace equipment. The 1031 exchange application automates the tracking of assets sold, matching to the replacement asset, and provides a tax solution, tracking the multitude of associated municipal, county and state taxes. The software automates what can be a complicated interdependent series of spreadsheets of fixed assets the company productively uses and replaces.
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1031 Exchange Holding Period
A 1031 exchange enables a taxpayer subject to US federal capital gains to defer the tax when selling and replacing real property held in the productive use of a business or for investment. Held is the key word, implying the property must be held for a period of time to qualify for a 1031 exchange. In the Internal Revenue Code Section 1031, a 1031 exchange holding period is not defined, though the IRS recognizes that two years is sufficient. In every 1031 exchange, facts, such as time the property is held, support the intent to hold the property to qualify for a 1031 exchange.
Vacation Property
In Revenue Procedure 2008-16, the IRS provides a safe harbor that if the taxpayer meets the time requirements, the IRS will not challenge whether the vacation home qualifies as property held for productive use in a business or for investment under section 1031. The vacation property must be held for two years and in each of those two years, the property must be rented out at fair market rent for 14 overnights. Given the replacement property is a vacation property, then it must be held for two years and rented out at 14 overnights at fair market rent for each year. Personal use must be limited to no more than 14 overnights per year. Overnights spent while maintaining the property do not count towards the 14 overnights.
Converting 1031 Rental to Primary Residence
When converting a rental or vacation property acquired in a 1031 exchange to a primary residence, the safe harbor applies, suggesting a two year hold as a rental prior to converting to a primary residence. To qualify for the Section 121 $250,000/$500,000 per taxpayer exclusion when selling the primary residence, the property must be held a total of five years, with at least two of those years as a primary residence. A primary residence is not an eligible replacement property when selling real property held for investment or in a business and initiating a 1031 exchange.
Hold Times of Less than Two Years
Intent while holding an investment property or in the productive use of a business can change due to work, health, family circumstances or unforeseen circumstances; consequently, the property can be exchanged in less than two years. The Revenue Procedure 2008-16 is a bright line test, but is optional unless the taxpayer wants the assurance the IRS will not challenge the 1031 exchange in an audit. Should the property be exchanged in less than one year, ordinary income taxes are triggered on the gain unless a 1031 exchange is initiated. If the property is sold after one year and a day, then long term capital gain rates apply which range for real property between 0 and 20 percent.
Flipping properties where the intent is for profit rather than for investment tends to not be eligible for a 1031 exchange, especially if the taxpayer flips multiple properties. The property must have facts that support the proper intent of holding for investment or in the productive use of a business. Itemizing the property on Schedule E and having the property managed by a property rental company with rental revenues, expenses and depreciation are good supporting facts.
The 1031 exchange holding period is exchange specific. Given good facts support the property, the hold period can range from less than a year to a conservative time frame of two years. Should you have questions regarding the sale of real or personal property, click here for a response from our team.
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
Defer Capital Gain in a 1031 Exchange When Selling a Business
Federal and state capital gain and depreciation recapture taxes can be deferred in a 1031 exchange when selling a business and replacing with like-kind fixtures and equipment. Otherwise, federal and state capital gain and depreciation taxes will represent upwards of 40 percent of the sales price. If the intent is to replace with like-kind property, then consider a 1031 exchange.
Business Sale
When a business is sold, such as a restaurant, the sale is composed of real and personal property, good will and possibly a non-compete clause, while the business assets are segregated into different asset groups, such as furniture, fixtures, cooking equipment and perhaps franchise rights or licenses. Good will and non-compete clauses are not eligible for a 1031 exchange. Many times the business leases the real property. If the lease is for greater than thirty years, the lease is eligible for a 1031 exchange. If not, personal property, both tangible and intangible, is the typical asset engaged in a 1031 exchange.
A personal property exchange only makes sense when the general asset class or North American Industry Classification System associated with the relinquished or old property matches the replacement property. If not, then the 1031 exchange does not work.
When selling a business, a dentist, veterinarian or optometrist interested in a 1031 exchange should visit their CPA to understand the tax consequences. Is there adequate depreciation recapture to warrant a 1031 exchange? If personal property is being sold, is the Taxpayer’s intent to replace with like-kind replacement property? Once these two questions are answered, the Taxpayer is in the position to determine whether or not to initiate a 1031 exchange. There are many rules to follow in a 1031 exchange. If the 1031 exchange rules are not followed and if ever audited, the IRS will surely overturn the 1031 exchange. An overturned 1031 exchange results in the tax being due, along with a possible penalty and interest due on the tax not paid.
Can leasehold improvements be exchanged? It depends. How does the lease handle leasehold improvements? Many times, leasehold improvements paid by the lessee are the property of and owned by the lessor. If the Taxpayer or lessee owns the leasehold improvements, then they can be exchanged for newly constructed tenant improvements in the replacement property.
Next, the Taxpayer should engage a Certified Exchange Specialist® to provide the Qualified Intermediary (QI) accommodation services for the 1031 exchange and discuss the transaction. The QI will ask questions and help the Taxpayer understand how a 1031 exchange applies to their sale and walk through the steps of the exchange.
If your business is located in Washington, Oregon, California, Nevada, Idaho, Colorado, Virginia or Maine, there are state mandated regulations the QI must follow or be subject to civil or criminal penalties. To protect your exchange funds, be sure to engage a QI that complies with these state laws. Each state requirement can be found by viewing the following page and selecting the state in the lower right hand corner.
A series of QI vetting questions are available for download by clicking on the button below. These are the questions experienced investors ask to understand the QI’s knowledge and experience to avoid engaging an accommodating accommodator.
Foreign Property 1031 Exchange
Taxpayers subject to US federal capital gain taxes due upon sale of foreign property can defer the tax when initiating a 1031 exchange for like-kind property that has a productive use in a business or investment located predominantly outside the US. Traditionally, when real or personal property is sold, a federal capital gain tax is imposed, ranging from 0 to 28 percent for collectibles. A 1031 exchange allows the Taxpayer to defer the tax given strict rules defined in Internal Revenue Code Section 1031 are followed. The tax deferral represents additional working capital or an indefinite, interest free loan to be used towards acquiring the replacement property within 180 calendar days of the relinquished or old property closing.
1031 Improvement Exchange
A 1031 improvement exchange is one of many types of 1031 exchanges that follow the same strict rules defined in Internal Revenue Code Section 1031. A 1031 exchange enables the Taxpayer to defer federal and state capital gain and depreciation recapture taxes when selling and replacing real and personal property held in the productive use of a business or for investment. Real property can only be replaced with real property while personal property must be exchanged for like-kind or like-class personal property. Property predominantly located in the US is only exchangeable for property held predominantly in the US. Foreign real and personal property are eligible for the tax deferral if exchanged for real and personal property held predominantly outside the US.