If you are a real estate investor, or someone looking to diversify your portfolio by relinquishing property that you currently own and replacing it with another similar real estate investment, you might be concerned about what your tax liability will be from the sale. IRS rules surrounding the sale of property require that you pay taxes on gains from a sale, but there are options to help you defer, or even eliminate, that tax liability. This is called a 1031 like-kind exchange, or a 1031 tax-deferred exchange.
The term “like-kind” property isn’t specifically defined in the tax code. IRC Section 1031 does not limit “like-kind” property to certain types of real estate. Any real property held for productive use in a trade or business or for investment can be considered “like-kind” property. The term refers to the nature or character of the property, rather than its grade or quality. Real property is generally considered to be of “like-kind” regardless of whether the properties are improved or unimproved. In a 1031 exchange, real property must be exchanged for like-kind real property and real property is not considered like-kind to personal property.
What Properties Are Not Considered Like-Kind?
A Primary or Secondary Residence: An Exchanger’s primary or secondary residence is not considered like kind and does not qualify for a 1031 exchange. It should be noted that primary residences do qualify for the tax exclusion, with certain restrictions, but under IRC Section 121 – not Section 1031.
Property held “primarily for resale” or “dealer property” is excluded from tax deferral under IRC Section 1031.
Qualifying Real Property
The types of real estate which can be exchanged are extremely broad. Any real estate held for productive use in a trade or business or for investment – whether improved or unimproved – is considered “like-kind.” Improvements to real estate refer to the grade or quality, not the nature or character of the real property. The rules surrounding 1031 like-kind exchanges do not require that the property you are selling or acquiring is the exact same type of real estate, but that the nature or character of the investment is similar. Generally speaking, any kind of real property that you hold as an investment can be exchanged for another property of the same purpose, including the following:
- Unimproved property
- Improved property
- Vacant land
- Net-lease property
- Commercial buildings
- Rental properties
- Farms or ranches
- Resort property
- Industrial property
- Retail property
- Office buildings
- Self-storage facilities
- Senior-living centers
- Hotels or motels
- Daycare facilities
- Tire and automotive stores
- TIC properties
- Deleware Statutory Trust (DST)
Like-Kind Exchange Examples
- Raw land exchanged for a TIC
- Office building exchanged for a DST
- Unimproved property exchanged for improved property
- Fee for a leasehold with 30+ years to run
- Commercial building exchanged for vacant land
- Duplex exchanged for commercial property
- Single-family rental exchanged for an apartment
- Industrial property exchanged for rental resort property
What About The Location Of Properties? US And Foreign…
Prior to 1989, Exchangers could exchange U.S. property for property outside of the U.S. However, for all exchanges occurring after July 10, 1989, only exchanges involving U.S. property could be considered “like-kind” for purposes of IRC Section 1031.
In other words, real property in the United States must be exchanged for other real property in the United States. Exchangers cannot exchange United States property for foreign property nor visa versa. Exchanging property in one state for property in another is allowed and extremely common.
However, in one Private Letter Ruling (PLR 9038030), an investor was allowed to exchange into the U.S. Virgin Islands as part of a qualifying §1031 exchange.
It’s important to remember that, as with any private letter ruling, it’s important to analyze the unique facts and circumstances of the taxpayer’s situation. The particular Private Letter Ruling mentioned above, allowed an exchange into the U.S. Virgin Islands because it cited a specific portion of the Code (Section 932), and in accordance with that the taxpayer specifically intended to have income derived from sources within the Virgin Islands and based upon this particular Code Section, the term “United States” was enlarged to include the U.S. Virgin Islands.
What About Exchanging Into Multiple Properties?
Exchanging from one property into multiple properties is allowed. Example: An exchanger can exchange a 100-acre parcel of unimproved land in Oregon worth $1.2M and acquire the following properties that will be held for investment:
- 40 acres of unimproved land in Kansas for $500,000
- A rental home near the Florida coast for $450,000
- A TIC or DST with the remaining $250,000
What About Personal Property?
Personal property that qualifies for a § 1031 exchange must be “held for productive use in a trade or business or for investment.” In general, qualifying properties must both be in the same General Asset Class or within the same Product Class. The Standard Industrial Classification Manual provides categories for General Asset Classes of depreciable tangible personal property. While you cannot trade real property (real estate) for personal property and vice versa under these rules, you can trade one type of personal property for a like-kind investment of other personal property.
It is critical to review any personal property transactions with tax advisors because the rules are more restrictive than for real property. Examples of qualifying personal property exchanges include:
- Mexican gold coins for Austrian gold coins
- Aircraft for aircraft
- Restaurant equipment for restaurant equipment
- Computers for computers
Some Special Considerations
Since there are several different rules and regulations that surround a 1031 tax exchange, it’s important to work with trusted advisors who can help you understand what property is protected under these rules, and ensure that you do not get stuck with a big tax bill. This includes understanding rules about how long you should hold the property before exchanging, and what types of property qualify under 1031 like-kind exchange rules.
At 1031 Exchange Place, we have worked with investors on many transactions and can provide the right guidance to complete your exchange. Contact us today to find out how we can help.
- Can I Exchange Multiple Properties In A 1031 Exchange?
- What Are The Benefits Of A 1031 Exchange?
- What Are The Tax Implications Of A 1031 Exchange?
- What Qualifies As Like-Kind Realty Under Irc Section 1031?
- Can I Exchange Personal Property In A 1031 Exchange?
- Which Real Estate Is Not Eligible For Section 1031?