From the Belong Homeowner Bureau: What You Need to Know About 1031 Exchange Rules Part 2
Written ByBelong on Oct 14, 2021
What is a Like-Kind Exchange?
The rules for 1031 exchanges state that properties are of like-kind if they’re of the same nature or character, even if they differ in grade or quality. In general, real estate properties are like-kind properties, no matter if they’ve been improved or not. But note that property in the United States and property outside the U.S. aren't like-kind properties.
The IRS states that if you make a like-kind exchange, you aren’t required to recognize a gain or loss under Internal Revenue Code Section 1031. However, if as part of the exchange, the owner also receives other (not like-kind) property or money, that not like-kind portion of the transaction must be reported to the IRS as a gain when measured against the other property and money received (The IRS says that a homeowner can’t recognize a loss).
For homeowners to receive the full benefit of a 1031 exchange, the replacement property must be of equal or greater value.
Are There Different Kinds of Like-Kind Exchanges?
Yes. There are three types of 1031 exchanges that vary by their timing and other details. Each has its own requirements and procedures:
1031 exchanges that are carried out within 180 days get this name because in the past, exchanges had to be performed simultaneously. In a delayed exchange, the homeowner relinquishes property before he acquires a new property. The “relinquished” property is transferred first, and the property the homeowner wants to purchase is acquired second.
This type of 1031 exchange permits the replacement property to be renovated or newly constructed. Note that because these exchanges are still subject to the 180-day rule, all improvements and construction on the exchanged property must be completed by the time the transaction is executed.
If a homeowner makes any improvements after this point, they won’t qualify as part of the exchange.
This is when a homeowner acquires the replacement property prior to selling the property to be exchanged. Here, the property must be transferred to what is called an exchange accommodation titleholder (which can be the qualified intermediary) and a qualified exchange accommodation agreement must be signed. With this type of exchange, a third party temporarily holds a homeowner's relinquished or replacement property.
A property for exchange must be identified within 45 days of the transfer of the property, and the transaction must be carried out within the same 180 days.
What Properties Are Eligible?
The IRS says that there are many forms of real estate that can be used for a 1031 exchange. This includes any property used for a business that includes a store, manufacturing facility, or office building.
Plus, investment property is also eligible for a 1031 exchange—this includes rental properties.
Again, the properties involved must be “like-kind.” The like-kind requirement is interpreted liberally, and almost all real estate properties qualify as like-kind. The types of like-kind properties may include:
- Single- and Multi-Family Rentals;
- Retail Shopping Centers;
- Office Buildings;
- Industrial Facilities;
- Storage Facilities; and
- Raw Land.
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What Properties Cannot Be Used in a 1031 Exchange?
There are several types of property that cannot be used for a 1031 exchange. They include the following:
- Stocks, bonds, or notes;
- Stock in trade or other property held primarily for sale;
- Other securities or evidence of indebtedness or interest;
- A partnership interests;
- Certificates of trust or beneficial interests;
- A chose in action , which is a right to something, like payment of a debt or damages in a lawsuit); and
- REITs, real estate funds.
There are powerful tax advantages of 1031 exchanges when you reinvest the proceeds from the sale of investment property into a replacement property. It’s important for homeowners to have a basic understanding of the IRS frameworks; if you are contemplating a transaction based on the advantages of the capital gains deferral, pay close attention to changes that might result from potential changes to the tax law that enables it.
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