Tax Deferred Exchanges, 1031 Exchanges, Starker Exchanges, Like-Kind Exchanges all refer to the exchanges of real investment property of “like-kind” pursuant to Section 1031 of the Internal Revenue Code, which provide as follows:
NO GAIN OR LOSS SHALL BE RECOGNIZED ON THE EXCHANGE OF PROPERTY HELD FOR PRODUCTIVE USE IN A TRADE OR BUSINESS OR FOR INVESTMENT IF SUCH PROPERTY IS EXCHANGED SOLELY FOR PROPERTY OF LIKE KIND WHICH IS TO BE HELD EITHER FOR PRODUCTIVE USE IN A TRADE OR BUSINESS OR FOR INVESTMENT
Tax-deferred Exchanges permit deferral of capital gains tax obligation and depreciation recapture when an investor trades investment property for a like-kind of property. As an actual swap of properties with another investor is highly unlikely, the investor will use the services of a qualified intermediary like CanZell Realty to accomplish a delayed exchange.
Who can Exchange?
Any tax-paying entity is entitled to the benefits of Section 1031. Individuals, corporations, LLCs, partnerships, trusts, and foreigners owning property in the US can all qualify. The taxpayer who sells the relinquished property must be the same as the taxpayer who purchases the replacement property.
Reason to Exchange?
1031 Exchanges allow taxpayers to own the type of property that helps achieve their
goals or solve their problems. It allows taxpayers to increase investment returns, meet business
needs, simplify their life by consolidating properties or relieving management responsibilities,
diversify portfolios, or relocate investment properties.
The Qualified Purpose
The properties involved in the exchange must be held for a qualified purpose (primary
residences, second homes exclusively owned for personal use, property held primarily for resale
and developers’ inventory do not qualify). Other properties excluded from tax deferred
exchanges are securities and partnership interests
The Like-Kind Requirement
Property must be exchanged for property of like-kind. This requirement is easily met
in real estate as all real estate is deemed to be like kind to other real estate – land can be
exchanged for a rental duplex, an office building can be exchanged for a shopping center so long
as they are located in the United States. As a result of the 2017 Tax Cuts and Jobs Act, 1031
exchanges are no longer available for personal property, such as equipment, art or livestock.
The Identification of Replacement Property is as follows:
THE 3 PROPERTY OF RULE
The 3 Property Rule
Up to three potential replacement properties can be identified
without regard to their value
The 200% Rule
If more than three potential replacement properties are sought to be
identified, then each property must be shown with its fair market value, and the aggregate fair
market value of all identified properties cannot exceed 200% of the value of the relinquished
The 95% Rule
If more than three properties are identified and their aggregate value
exceeds 200% of the value of the relinquished property, then the investor must acquire 95% of
the identified value in order for the exchange to be valid.