Tools and Investment
Qualified Properties: Exchange Requirements for a 1031 or Deferred Exchange
There are three prerequisites that must be met to accomplish a 1031 with complete non-recognition of capital gains. The properties being exchanged must qualify and be of “like-kind”; There must be an actual exchange, not a transfer of property of money only; and the time requirement must be strictly followed.
For a 1031 exchange to happen, both relinquished property and replacement property must qualify. In other words, both the property you are selling and buying must be qualified property and like-kind property. Else, the exchange would fail and be classified as a sale.
For income tax purposes, the real properties are classified on the date the transaction is made. These classifications can help determine whether your property can be qualified for a 1031 exchange or not. There are four classifications, which are: held for business use, held for investment, held for personal use, and held primary for sale (dealer property). And amongst the four, the real estates held for business and for investment are the only ones that qualify for 1031 treatment.
The Difference Between Real Estate Used In Business and Real Estate Held for Investment
Real estate used in trade or business could be owner occupied wherein the property is used in the owner’s trade or business; or rental income property where a different party is/are renting out the property. Real estate used for business is known in the Internal Revenue Code as IRC 1231 real estate.
Investment real estate is a property held primarily for appreciation of value due to location, passing of time, and other factors outside the activities of the owner. This type of real estate property is called a capital asset (IRC 1221).
Like-Kind Properties
This is a tax term relating to the nature or character of the real estate in the hands of the owner not referring to its grade or quality. Any qualified property located in the US is of like-kind when exchanged with another qualified property in the US and US Virgin Islands. Properties outside the 50 United States of America used for the exchange are not like-kind and are treated as boot paid or received.
Assets that are Excluded in 1031 Exchanges
Section 1031 excludes the following assets from nontaxable treatment whether or not they are related to real estate: property held primarily for inventory or sale, stocks, bonds, notes, account receivables, certificates of trust or evidences of indebtedness.
Vacation homes or second home not held as a rental is classified as real estate held for personal use and does not qualify fir 1031 treatment. However, if it is used for both personal use and rental purposes, then it must undergo a use test each tax year to determine its tax classification for that tax year.
Be reminded that some properties have more than one classification during the time of sale such for example is the sale or exchange of a duplex or a townhouse where the seller lived in one unit and rented out the other unit/s. The sale or exchange is allocated between the real estate held for business use (the other units), and the real estate held for personal use (the unit being resided in).
It also does not require that the exchange be solely business property for business property or investment property for investment property. The two classifications could be mixed.
For a 1031 exchange to happen, both relinquished property and replacement property must qualify. In other words, both the property you are selling and buying must be qualified property and like-kind property. Else, the exchange would fail and be classified as a sale.
For income tax purposes, the real properties are classified on the date the transaction is made. These classifications can help determine whether your property can be qualified for a 1031 exchange or not. There are four classifications, which are: held for business use, held for investment, held for personal use, and held primary for sale (dealer property). And amongst the four, the real estates held for business and for investment are the only ones that qualify for 1031 treatment.
The Difference Between Real Estate Used In Business and Real Estate Held for Investment
Real estate used in trade or business could be owner occupied wherein the property is used in the owner’s trade or business; or rental income property where a different party is/are renting out the property. Real estate used for business is known in the Internal Revenue Code as IRC 1231 real estate.
Investment real estate is a property held primarily for appreciation of value due to location, passing of time, and other factors outside the activities of the owner. This type of real estate property is called a capital asset (IRC 1221).
Like-Kind Properties
This is a tax term relating to the nature or character of the real estate in the hands of the owner not referring to its grade or quality. Any qualified property located in the US is of like-kind when exchanged with another qualified property in the US and US Virgin Islands. Properties outside the 50 United States of America used for the exchange are not like-kind and are treated as boot paid or received.
Assets that are Excluded in 1031 Exchanges
Section 1031 excludes the following assets from nontaxable treatment whether or not they are related to real estate: property held primarily for inventory or sale, stocks, bonds, notes, account receivables, certificates of trust or evidences of indebtedness.
Vacation homes or second home not held as a rental is classified as real estate held for personal use and does not qualify fir 1031 treatment. However, if it is used for both personal use and rental purposes, then it must undergo a use test each tax year to determine its tax classification for that tax year.
Be reminded that some properties have more than one classification during the time of sale such for example is the sale or exchange of a duplex or a townhouse where the seller lived in one unit and rented out the other unit/s. The sale or exchange is allocated between the real estate held for business use (the other units), and the real estate held for personal use (the unit being resided in).
It also does not require that the exchange be solely business property for business property or investment property for investment property. The two classifications could be mixed.
Publisher: Akbar Bhamani Date posted: 05/22/2007
