Determining if your Property Qualifies for a 1031 Exchange

A 1031 exchanged is called that because the section in the tax code that deals with these tax deferred property exchanges is Section 1031 in the Internal Revenue code. This section states that property owners can sell their property and reinvest the proceeds in the ownership of like-kind properties and defer the capital gains taxes. There are qualifications, rules and requirements for property owners to be able to qualify for like-kind exchanges, which we will deal with later in this article. These property exchanges can offer significant tax advantages to real estate buyers.
A property owner who will gain a profit on the sale of their property which they have owned and or rented and has been substantially depreciated over time or has appreciated in fair market value may be a prime candidate for a 1031 exchange. These are the five tax categories that property owners may fall into:

1. Property that was used in a taxpayers trade or business
Business use is defined in the code as “To hold property for productive use in trade or business”. If the property is retired from previous productive use as a business, this can qualify the property for 1031 exchange.

2. Property that was held primarily for sale to customers

3. Property that was used as your principal residence

4. Property that was held for investment purposes
Investment purposes is defined as real estate, even if unproductive, held by a non-dealer for future use or increment in value is held for investment and not primarily for sale.

5. Property that was used as a vacation home.
Investment is the passive holding of property, for more than a temporary period, with the expectation that it will appreciate, however property held for sale in the immediate future is not held for investment.

Only the first and fourth categories and in some occasions the fifth would qualify for a 1031 exchange. There are three basic rules that apply to the 1031 exchange. Rule one states that the property you sell and the property you buy must both be held in a productive use or for investment purposes and must be like-kind. Examples of 1031 like-kind exchange properties include apartments, commercial, condos, duplexes, raw land and rental homes. The second rule states that the sale proceeds may not be held by you but have to go through an agent or intermediary. Rule three states that all the proceeds from the original sale must be re-invested in the replacement property or properties. Any of the proceeds that are left are taxable and the replacement property must be of greater or equal value.
You may identify any three properties as possible replacements for your relinquished property but once sold it does have time limitations. You have 45 days to identify suitable replacement properties. You can also identify more than one property as long as the total value of all replacement properties does not exceed 200% of the relinquished property. You can also identify any number of properties as long as you end up purchasing 95% of the total value of all the properties that you have identified.