Tools and Investment
Learning Starker: Bits about Section 1031 Exchanges
1031 exchanges are almost exclusively used in real estate, but they can be used for other types of assets as well and to qualify, property owners generally should exchange real estate or land (relinquished property for business or investment) for other business or investment (replacement) property of a like-kind. When properties are called like-kind, this means they are of the same nature or character, whether they are improved or unimproved.
Real property is not like-kind to personal property, but combinations of the two may qualify under Section 1031 rules. Such for example an investor could not exchange his restaurant and its furnishing and equipment solely for real or personal property in a completely tax-free exchange, but could however exchange the property for another combination of real and personal property, such as a warehouse including some of its equipments. Exchanges that involve multiple property exchange may result in the recognition of some gain as it is unlikely of equal value.
Section 1031 does not apply to exchanges of inventory, stocks, bonds, notes, other securities or evidence of indebtedness, or certain other assets.
A qualified intermediary is required to have a 1031 exchange and there is a holding period for the property after the exchange. The IRS might challenge the exchange if the investor decides to sell the replacement property shortly after the exchange.
The QI or the qualified intermediary facilitates the 1031 exchange and this independent party cannot be the investor or the buyer or any disqualified person. Without one, you have to meet one of the IRS’ complicated safe harbor requirements to successfully complete the exchange. The QI acquires the relinquished property and transfers it to the buyer; the intermediary also holds the sales proceeds, since the investor should not have actual or constructive receipts of the funds; and finally, the QI acquires the replacement property and transfer it to the investor. All of this under the appropriate time limits of the exchange.
Overall, it is best to consult a tax advisor, a qualified intermediary or an attorney for more information about Section 1031 exchanges and to determine how an exchange may be best structured to accomplish your investment objectives.
Publisher: Akbar Bhamani Date posted: 05/21/2007
