1031 Like-Kind Exchanges have grown in popularity as an effective tax deferment strategy. It can be used to defer the gain on real property not held primarily for sale. The real estate market has changed and many of our real estate investment clients have exchanged properties in expensive markets for cash flowing properties in less expensive areas using the 1031 Exchange program. Section 1031 like-kind exchange treatment can only be used for exchanges of real property held for use in a trade or business or for investment, other than real property held primarily for sale.
The Like-kind exchange must be used to acquire “like-kind” property. An example would be the sale of residential rental real estate property for the acquisition of commercial rental real estate property. Deferred gain will be recognized upon sale of replacement property, unless a Like-Kind Exchange is used again, in which the gain will be deferred again. Another example would be the sale of a residential real estate property in a pricy area for the acquisition of several residential real estate properties in more affordable areas.
Requirements to complete a Like Kind Exchange:
- Relinquished property in United States must be replaced with replacement property in the United States. Relinquished property located outside the United States must be replaced with replacement property located outside the United States.
- To defer 100% of the gain, replacement property must be equal to or greater than relinquished property. If replacement property is less than the relinquished property a partial deferral is available.
- Multiple properties can be acquired to achieve replacement property value equal to or greater than relinquished property.
- 100% of the cash proceeds from the relinquished sale of real estate must be re-invested to defer 100% of the gain on the relinquished property. Partial deferrals are also allowed
- Seller of real estate must not receive any of the cash proceeds from the sale of the relinquished property. All cash proceeds must be distributed and held by Qualified Intermediary at time of closing for the relinquished property.
- Relinquished property sale proceeds must be used to acquire replacement property. In addition to relinquished sale cash proceeds, a mortgage can be used to acquire replacement property equal to or greater relinquished property.
- Replacement properties must be identified within 45 days of settlement of the relinquished property.
- Closing on replacement property must take place within 180 days of the closing on the relinquished property.
- Closing on replacement property must also take place before the due date for filing the tax return for the year in which the relinquished property was sold. This date would also be extended with obtaining an automatic extension for that entity.
- Replacement property must be held for productive use for the foreseeable future, as to not violate “disguised sale” rules. A “Reverse 1031 Exchange” can be used when replacement property is acquired before the relinquished property is sold. Replacement property must be purchased using an Exchange Accommodation Titleholder.