The benefits of completing an Internal Revenue Service 1031 tax exchange provide compelling reasons for any taxpayer selling property held for investment or trade or business to consider a 1031 exchange. To defer 100 percent of the federal, state and local capital gains and recaptured depreciation taxes requires the taxpayer to reinvest 100 percent of the net sales proceeds and retired debt from the sale of the old property held for the proper intent for a new like kind property.
Partial 1031 Exchange
A partial exchange is possible given the replacement property net purchase price is at least 60 percent of the old property net sales price; otherwise, the tax paid on the 40 percent may be close to the tax that would be paid on the transaction without a 1031 exchange. The tax deferral can easily represent 40 percent of the old property sales price. There are strict rules that must be followed and failure to do so will disqualify the 1031 tax exchange. Here are some of the IRS 1031 exchange rules.
Like Kind Exchange Requirement
The IRS Code Section 1.1031 states that no gain or loss is recognized on the exchange of property held for productive use in a trade, business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade, business or for investment. Property means both real and personal property. Generally speaking, real estate will always be considered like kind to other real estate, regardless of the improvements on the land. The exception is that property located outside the United States is not considered like kind to property within the United States. Real property held internationally for real property held abroad is eligible for a 1031 exchange given the taxpayer is subject to US income taxes. Personal property must be exchanged for personal property of the same asset class or group per the North American Industry Classification System or Standard Industry Classification codes.
Like Kind Exchange Examples
Examples of like kind tangible or intangible personal property include a jet for a helicopter, front loader for front loader, furniture for furniture, oil painting for oil painting, vintage car for vintage car, livestock or a bull for bull, gold bullion bar for gold bullion coins, record copyright for record copyright and patent for patent.
What is not eligible for 1031 consideration is a primary residence, partnership interests, inventory, indebtedness and securities.
Timing
Timing is critical in a 1031 IRS tax exchange. Within 45 calendar days of the sale of the old property, the replacement property must be identified (with the appropriate parties notified). Within 180 calendar days of the sale of the old property, the acquisition of the new replacement property as noted above must be completed. These time lines are in place to discourage property owners from “sheltering” their sales proceeds from taxes for long periods of time if there is no intent to complete a 1031 tax exchange. The 45 and 180 day rules are very strict and for the most part will not be extended for any reason with the exception of natural disasters or if the taxpayer is in a combat zone during the exchange. The 1031 exchange time line extensions are posted on the IRS website for hurricanes, tornadoes, floods and fires.
Qualified Intermediary
The majority of 1031 tax exchanges that involve real estate are completed with three to four parties, and not simultaneously, meaning the sale of the old property and purchase of the new property are not completed at the same closing. In a two party exchange, a qualified intermediary is not required, given the Seller and Buyer want each other’s property. This is also known as a “pure” exchange and is typically completed at one simultaneous closing.
The qualified intermediary was a term introduced by the IRS in the early 1990s to prevent what is referred to as constructive receipt or the g(6) limitations of the 1031 code. The IRS states that, “taking control of cash or other proceeds before the exchange is complete may disqualify the entire transaction from like kind exchange treatment and make ALL gain immediately taxable.” Consequently, the proceeds of the sale must be held in an escrow account from the time of sale until the exchange is complete with a qualified intermediary. A Certified Exchange Specialist© provides the public with a qualified intermediary that follows a strict Code of Ethics and Prudent Investment Standards to ensure preservation of principal and liquidity.
For a complete review of IRS 1031 exchange rules, review the following link. To learn the questions seasoned taxpayers ask when vetting a qualified intermediary, click on the button below.
