Section 1031 (like-kind) Exchanges
Tax planning for selling your business, investment, or rental property

What is Section 1031 - Section 1031 (click on the link to view the entire text of the Code section) of the Internal Revenue Code governs the exchange of business, rental, or investment assets. While it is most often thought of in terms of real estate, it applies to ALL qualifying assets. Additionally, it is NOT elective, it is mandatory. What it says, in its most basic form, is that when you exchange one asset solely for another asset of like kind, you do not RECOGNIZE any gain or loss on the exchange. This contrasts with the general rule which is that gain or loss IS recognized when you exchange one asset for another.

The obvious benefit of Section 1031 exchanges is the deferral of tax on the gain that you have realized. But there are other benefits as well. By using 1031 exchanges, you can increase your leverage and ROI, preserve equity, diversify your holdings, and do some estate planning.

Like kind property is defined by the code, regulations, and court cases. The rules are sometimes confusing. Real estate that is a single-family residential rental property is like-kind with commercial rental property, raw land, an apartment complex, or even certain leasehold interests. At the same time, a cow is not like-kind with a bull.

When you decide that you want a new vehicle for your business, most likely you will "trade in" your current vehicle as partial payment for the new one. This is a 1031 exchange in its simplest form. However, when you get ready to sell that rent house that you have owned for 15 years, it is unlikely that the buyer will have a property that you want to trade for. Enter what is commonly known as a 1031 exchange. In this situation, you enter into an agreement with a third party (a qualified intermediary) to sell your property on your behalf and hold the proceeds in an account for you. Then you find a property that you want to own and the qualified intermediary purchases it on your behalf and delivers the title to you.

As with many potential tax benefits, there is a myriad of rules and bad news awaits if you make a misstep along the way. You should always seek professional counsel prior to entering into an agreement to sell any property that you own.

Keep in mind that the ideas presented are, by necessity, of a general nature. We would be happy to discuss how these, or other ideas, apply to your specific situation. Click here to send us an email.

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