Section 1031 – Like kind exchange is when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or “like-kind”.
Generally, if you make a like-kind exchange, you are not required to recognize a gain or loss under IRC Section 1031. If, as part of the exchange, you also receive other (not like-kind) property or money, you must recognize a gain to the extent of the other property and money received. Loss can’t be recognized.
Properties are of like-kind if they’re of the same nature or character, even if they differ in grade or quality and regardless of whether they’re improved or unimproved. Exchanging land with another land may qualify but exchanging property within the USA with another outside the USA does not qualify.
Under the Tax Cuts and Jobs Act, Section 1031 now applies only to exchanges of real property and not to exchanges of personal or intangible property.
Section 1031 doesn’t apply to exchanges of real property held primarily for sale. Real property must be productively used in a trade or business or held for a production of income.
Special rules apply when a depreciable property is exchanged in 1031. It can trigger a profit known as “Depreciation Recapture” that is taxed as ordinary income. This can make the whole process non beneficial.
Under section 1031, any proceeds received from the sale of a property remain taxable. A qualified intermediary must be used to handle all the paperwork and hold the sale proceeds during the exchange period.
The investor will have a 45-Day Identification Period, starting at the closing of the disposed property, to identify up to 3 properties to purchase. If this requirement is not met, 1031 exchange is a failure and the proceeds from the sale will be returned to the investor and will not be able to defer the capital gains tax. Additionally, acquisition of the identified properties must be completed within 180 days. Failure to take ownership on or before the 180 days period will result in a failed exchange.
We, at Taxville Financial, take a consultative approach to help our clients make informative decisions. We can guide you through the process and help you grow your investments with minimal tax implications.
Michael Zachary, EA, CPHRC