Section 1031 exchanges, also called like-kind exchanges, have been around nearly a century. They involve swapping one property for another and if structured correctly, can let you defer tax on any gain.
REAL PROPERTY
The 2017 Tax Cuts and Jobs Act limited 1031 exchanges to real property used in business or held for investment. However, if a large part of your business involves selling real property quickly with no intent to hold it as an investment (i.e. a homebuilder or a fix-and-flipper), these types of properties are excluded from 1031 exchanges. Likewise, your primary residence will not qualify but your vacation rental may qualify if certain use requirements are met.
LIKE-KIND
Property involved must be similar in nature and character but can differ in quality. In general, all real property is like-kind. An apartment building is like-kind to a warehouse. However, real property in the U.S. isn’t like-kind to real property outside the U.S.
FIND AN INTERMEDIARY
Unless you’re able to find someone, who wants the exact property you have and has the exact property you want, you’ll need a qualified intermediary. You’ll relinquish your property to them, they’ll sell it to the buyer, and hold on to the cash proceeds until you find your replacement property. There are strict timing rules for these types of delayed exchanges. You must designate the replacement property within 45 days and close within 180 days of the sale of your relinquished property.
BEWARE OF BOOT
Boot is anything you receive that isn’t like-kind property and boot is taxable to the extent you recognize any gain.
If you relinquish a property worth $400,000 and acquire a property worth $300,000, the $100,000 difference you receive in cash is boot.
Boot isn’t always cash. It could be a promissory note from the buyer or tenant security deposits you receive as the new landlord.
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