What Types of Properties Qualify for a 1031 Exchange?
A 1031, or “like-kind,” exchange allows private investors, corporations, LLCs, and partnerships to swap one qualifying investment for another of equal or greater value without having to pay federal taxes on gains at the time of sale as long as they roll all the proceeds into the new investment. The fact that you can use a 1031 exchange to defer capital gains taxes indefinitely – even after your death – makes them a potent tool for building and maintaining wealth.
Private investors use 1031 exchange properties to defer taxes in a number of different assets, including some personal property – artwork and other collectibles, for instance. Corporations use exchanges to make infrastructural improvements and to upgrade equipment. Many assets qualify, with the following exceptions:
• Inventory or stock in trade
• Stocks, bonds, or notes
• Other securities or debt
• Partnership interests
• Certificates of trust
The tax code originated in 1921 so that farmers could swap land parcels without losing any purchase power, and real estate has been one of the primary industries to benefit ever since.
“Like-Kind” May Not Mean What You Think
Although “like-kind” is a specific designation for some assets – for instance, you cannot exchange a truck for a car – real estate is more flexible. You can swap just about any kind of property for just about any other kind of property, if you meet a few qualifying factors:
• You cannot buy or sell property that you intend to use as a primary residence.
• You cannot buy property that you intend to “flip” quickly for profit.
• While you can sell a property to a related party, you cannot purchase the replacement property from a related party.
• The property must be in the United States.
• From the time of sale, you have 45 days to identify no more than three potential replacement properties in writing.
• You take no more than 180 days to purchase at least one of the identified properties.
• You use a qualified intermediary to hold the sale proceeds in escrow.
• The new property is of equal or greater value than the property you sell.
In terms of what properties you can buy and sell, however, the code is very flexible. You can sell raw land and purchase an apartment complex using a 1031 exchange. You can swap multiple properties for one property of equal or greater cumulative value, or you can use the exchange to purchase replacement property interests (RPIs).
The reason for this flexibility is simple: “Like-kind” refers not to the type of property but to its intended use. In order to be eligible for the swap, both properties must be long-term investments.
Common Ownership Scenarios
• Sole Ownership, with Full Landlord Responsibilities
A private investor who buys a rental house is the classic example of a sole owner, but any property that you own yourself and lease to other individuals or businesses qualifies. In this scenario, the owner retains full control over the investment property rather than placing these responsibilities in the hands of an intermediary.
• Sole Ownership, with a Managed Property
Using a full-time management company to handle an investment property such as an apartment complex or retail space is one example of limited landlord responsibility. In exchange for some of the profit, the firm assumes responsibility for collections, leasing, and maintenance.
• Sole Ownership, with a “Triple Net Lease” Property
This arrangement removes the owner even further from landlord responsibilities. A “triple net” is a property, typically a business franchise, where the tenant pays the three “nets” – insurance, maintenance, and real estate taxes – in addition to usual fees like rent and utilities.
• Replacement Property Interests
RPIs allow investors to own fractional interest in a managed real estate portfolio held under a Delaware Statutory Trust. Unlike other real estate co-ownerships, they are eligible for 1031 swaps as long as you and the other property owners are not considered partners by the IRS.
In order to qualify for a 1031 exchange, you do not need to have a strictly “hand’s off” relationship with the property – in this way, 1031 exchange properties offer more freedom than properties held through self-directed IRAs.
About Peak 1031 Exchange, Inc.
Peak 1031 Exchange, Inc. is a leading national provider of tax-deferred 1031 exchange services for private investors and larger enterprises. They help investors understand the complexities of valid exchanges, maintain equity while diversifying their portfolios, and conduct a variety of transactions, including process management for simultaneous, delayed, reverse, improvement, business asset, and personal property exchanges. Offering private and conventional financing, and specialized escrow services, Peak 1031 Exchange, Inc. is a one-stop solution for individuals and companies seeking to build wealth through real estate investment.