Both the relinquished property you sell and the replacement property you buy must meet certain requirements. Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like kind exchange treatment.
Real property and personal property can both qualify as exchange properties under Section 1031, but real property can never be like kind to personal property. In personal property exchanges, the rules pertaining to what qualifies as like kind are more restrictive than the rules pertaining to real property. As an example, cars are not like kind to trucks.
Both properties must be similar enough to qualify as "like-kind." Like kind property is a property of the same nature, character, or class. Quality or grade does not matter. Most real estate will be like kind to another real estate.
For example, real property that is improved with a residential rental house is like kind to vacant land. One exception for real estate is that property within the United States is not like kind to property outside of the United States. Also, improvements that are conveyed without land are not of like kind to land.
What property qualifies for a Like Kind Exchange?
Any property held for productive use in trade or business or for investment can be exchanged for like kind property.
Like kind refers to the nature of the investment. Any type of investment property can be exchanged for another type or like kind investment property. For example, a single family rental can be exchanged for a duplex, raw land for a shopping center, an office for apartments. Any combination works and provides Exchangers with great flexibility.
Ineligible 1031 Exchange Property
The following properties may not be exchanged using Section 1031: a personal residence (unless a portion of the personal residence consists of business property), stock in trade, developed lots, property held for resale immediately after acquisition or completion of improvements (speculation homes or fixer type properties that are not rented out or held onto for a period of time before being sold), the goodwill of a business, and partnership interests. Second homes may or may not qualify depending on the use and tax treatment.
How do you compute the basis in the new property?
The basis of property acquired in a Section 1031 exchange is the basis of the property given up with some adjustments. This transfer of basis from the relinquished to the replacement property preserves the deferred gain for later recognition. A collateral affect is that the resulting depreciable basis is generally lower than what would otherwise be available if the replacement property were acquired in a taxable transaction.
Definition of Like-Kind Property Per Tax Code
Nonrecognition of gain or loss from exchanges solely in Kind. No gain or loss shall be recognized on the exchange of property held for productive use in trade or business or for investment. This does not apply to any exchange of stock in trade or other property held primarily for sale, nor stocks, bonds, notes, chooses in action, interests in partnerships, certificates of trust or beneficial interest, other securities or evidence of indebtedness or interest.
Property Specifically Excluded 1031
1031 does not apply to exchanges of:
• Inventory or stock in trade
• Stocks, bonds, or notes
• Other securities or debt
• Partnership interests
• Certificates of trust
How do you report Section 1031 Like-Kind Exchanges to the IRS?
You must report an exchange to the IRS on Form 8824, like kind exchanges, and file it with your tax return for the year in which the exchange occurred. If you do not specifically follow the rules for like-kind exchanges, you may be held liable for taxes, penalties, and interest on your transactions.
"As the leading provider of 1031 exchange solutions in the industry, Granite Exchange has established the most rigorous industry standards in voluntary compliance, transactional transparency, and funds security. Our industry-leading best practices aim to set a higher standard for QI accountability."
Justin Swift CES
Managing Partner and Owner of Granite Exchange
Kansas State 99 BA Business
1999 NFL Draft - Denver Broncos
Certified Exchange Specialist (CES)
Licensed Series 6, 63, 7
Since starting his career in professional sports Justin Swift's focus on tax and wealth management has paved the way for over 15,000 successful exchanges. Granite Exchange provides high-touch investment expertise that centers on diversified solutions and a service-led approach. With an in-depth understanding of the intricacies of the tax code, every aspect of our advice from assessment to implementation is tailored to your unique requirements.