1031 Exchange Insight
Posted by Andy Gustafson on Wed, Feb 15, 2012
The 1031 Exchange General Rule
Often, the sale of property results in a financial gain. That financial gain, in turn, can incur capital gains taxes. Section 1031 of the Internal Revenue Code, however, provides for an exception to the general rule regarding capital gains taxes when certain property is sold and exchanged for “like-kind” property. According to the Internal Revenue Code, a 1031 Exchange applies to “the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.”
A Real World Example
So how does this apply in a real world sale? A common example of a 1031 Exchange is the sale of real property that has been held as an investment. For example, if you own a home that you rent out and decide to sell the home, any gain from the sale would be subject to capital gains taxes. If, however, you then replace that property by purchasing another home that you subsequently use as a rental property, you may be able to avoid paying capital gains taxes by claiming a 1031 Exchange. Replacing the rental property with a property that you intend to live in, however, would not be considered a “like-kind” exchange.
Who Qualifies?
Anyone who owns business or investment property may potentially qualify for a Section 1031 Exchange. This includes not only individuals, but S & C corporations, partnerships, limited liability companies and trusts as well.
Exchange Timeframe
In order to enjoy the benefits of a 1031 Exchange, the exchange must be completed within 180 days. This is a very important facet of the 1031 Exchange. If, for example, you sell an investment property, you must purchase a replacement property within 180 days or you lose the benefits of a 1031 Exchange.
Like-Kind Property
The requirement that you replace what you sold with “like-kind” property has been the subject of much debate and litigation. Selling an investment property and replacing it with another investment property may be a clear case of a qualifying 1031 Exchange; however, many other exchanges are not as clear. For example, the Internal Revenue Service (IRS) disallowed the exchange of bullion-type gold coins for numismatic-type gold coins, but did allow the exchange of gold bullion for Canadian Maple Leaf gold coins. The difference between the two being that, according to the IRS, numismatic coins are not purchased for the same reason as bullion coins whereas Canadian Maple Leaf coins are purchased for the gold value just as gold bullion is and therefore it is a “like-kind” exchange.
Exceptions
The IRS has specifically excepted certain transactions from qualifying for a 1031 Exchange. Property that cannot benefit from a 1031 Exchange includes stocks, bonds and notes as well as interests in a partnership, certificates of trust or beneficial interest and choses in action. Other types of securities or evidence of indebtedness or interest are also specifically excluded from a 1031 Exchange. If you are uncertain whether your transaction qualifies, contact our office at 800.227.1031 or andgus@atlas1031.com.
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