1031 Exchanges - A Look At Like Kind Properties
When participating in a 1031 exchange there are several requirements that must be met to qualify for the tax benefits offered by this type of transaction. We’re going to look at perhaps the most important of those requirements: the need to exchange property for one a like kind. We’ll discuss the particulars of that rule in a moment. But first let’s see exactly what a 1031 exchange is.
To start, the number 1031 refers to the Section of the IRS tax code that deals with the rules of the procedure. A 1031 exchange allows an individual to trade or exchange one piece of real property for another of like kind and of equal or greater value while deferring any capital gains that would be due from profits of the transaction. Such a transfer might occur one of two ways.
An individual wanting to divest of a property might locate a buyer for that property who also has a comparable piece of real estate that he or she wants to sell. Let’s say each party had a residential home. Since these would be considered like properties, the exchange would take place by placing deeds to each property with a qualified intermediary. When the conditions of the exchange were all met, the intermediary would transfer titles to each new owner. This is known as a simultaneous exchange. Each participant would realize tax benefits on an exchange like this.
The other possibility is a delayed exchange and is much more common. Let’s say that the same individual with a residential home is looking to do a 1031 exchange. Under the provisions of the tax code, that person could sell his property outright and place the proceeds with a qualified intermediary. Once done, the seller would have 45 days from the date of the sale to locate and identify a property to complete the transaction and 180 days from the sale date of his property to close on it. Only the first party would receive tax benefits on this exchange unless the seller completing the exchange made arrangements for his own swap.
Okay, with the basics out of the way let’s take a closer look at the meaning of like kind. A good rule of thumb with regard to determining like kind is this: Like kind is determined more by use than type and the property must have the same nature and character. One might mistakenly believe that a tract of raw farmland and a tract of commercial land would not be like kind properties. And on first glance that would be correct. However, the determining factor would be how the owners used them. If each were purchased as investments, they’d be eligible as like kind properties and would qualify under exchange rules.
Generally speaking tax deferred exchanges most commonly take place with investment or income producing real estate, however, residential property certainly qualifies. Sometimes it’s easier to understand what qualifies by looking at what doesn’t meet the criteria of like kind property. The following are not considered like kind properties:
- Real estate in the United States and real estate outside of the United States regardless of its use.
- Property other than real estate; cash, cars, boats, machinery, debt instruments and other property. Non real estate items may be used in a 1031 exchange but it should be noted that such property is subject to capital gains.
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October 15th, 2008 at 4:30 am
This is a great summary on 1031 exchanges. I think that this is an area of investing that is confusing to a lot of people. Good explanation.