What are the 1031 Exchange Qualifications?
Both the relinquished property you sell and the replacement property you buy must meet certain qualifications. The 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 a vacation home, does not qualify for like-kind exchange treatment.
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 other real estate property.
Like-kind refers to the nature of the investment. Any type of investment property can be exchanged for another type of like-kind investment property. For example, a single-family rental can be exchanged for a duplex, raw land for a shopping center, and an office for apartments. Any combination works and provides Exchangers with great flexibility.
No recognition 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, choices in action, interests in partnerships, certificates of trust or beneficial interest, or other securities.
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.
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
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.
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.