1031 Exchange Rules and Updates (2022)

Get the basics, track the latest changes and rules, or ask our experts specific questions.

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Review the 1031 rules

Learn how to do a 1031 exchange.

Review the 1031 rules

I thought doing a 1031 exchange would be complicated and expensive, however 1031x made the process super simple. 

Katherine Quigg, real estate investor

Get quick answers.

Here are some common 1031 exchange rules explained.

A 1031 exchange allows real estate investors to defer their capital gains taxes (and other income taxes) when selling a property. Investors must reinvest in another qualified asset.

The strategy comes from Section 1031 of the Internal Revenue Code.

To execute a successful 1031 exchange, here are the basic steps

  1. Hire a qualified intermediary (such as 1031x)
  2. Sell your relinquished property
  3. Identify potential replacements within 45 days
  4. Purchase a replacement property of equal or greater value
  5. Close on your replacement within 180 days

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Almost anything.

The IRS allows exchanges of and between any properties held for “productive use” or “investment.”

However, you may not trade property in the United States for foreign property under IRC § 1031.

The logic behind tax deferral under IRC § 1031 is to allow individuals or businesses to trade older and less-expensive investment properties for more valuable and productive properties.

For more on this, please visit the advocacy page for the Federation of Exchange Accommodators.

The main benefit of a 1031 Exchange is greater tax efficiency, which translates into more purchasing power and investor flexibility. Used correctly, this means higher returns, more cash flow, and even improved estate planning through the power of stepped-up basis transfers.
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See recent regulations.

1031 like-kind exchange rules (and interpretations of those rules) change across time.

Below, you’ll find:

  • IRS rules (updated for 2021)
  • Treasury Regulations
  • 1031 exchanges under 26 U.S.C. § 1031 (including recent and potential developments)
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IRS Issues Final Regulations on Definition of “Real Property”

Following the publication of additional proposed regulations on June 12, 2020 (see below), The Internal Revenue Service received 21 written comments in response.

You can read those comments here.

After consideration, the Treasury Department adopted the following final definition of “real property

Source: Department of the Treasury

Read the full guidance here.

Statutory Limitations on Like-Kind Exchanges

On June 12, 2020, The Internal Revenue Service published additional proposed regulations (and clarifications of prior regulations) addressing which assets qualify for 1031 exchanges in light of the Tax Cuts and Jobs Act. 

Below, we break down the proposal to simpler language.

And we cut out a lot of the chaff.

Defining “real property” as it pertains to Section 1031 like-kind exchanges.

(Remember, taxpayers can only defer taxes on exchanges between “real property”)

The Tax Cuts and Jobs Act of 2017 (TCJA) limited like-kind exchanges to “real property”. In this context, “real property” largely means “investment real estate”

Thereafter, tax-deferred exchanges for “personal property” went away (airplanes, cars, art, etc)

All of this highlighted a pre-TCJA artifact of the tax code: 

There are multiple, disparate, and often incompatible definitions of “real property” 

Rather than adopt one of the existing definitions, the IRS and Treasury decided to propose a new definition.

Definitions of “real property” are multiple and varied across different tax code sections.

For example, the following definition is found in §1.263(a)-3(b)

and this is materially different than what the IRS writes in §1.856-10, etc)

Currently (as of this writing), the IRS has not made clear precisely which definitions apply to assets under §1.1031(a)-1(c)  (i.e. Section 1031)

  1. “Real property” in 1031 includes
    • Land
    • Improvements to land
    • Unsevered crops
    • “Natural” land products (think minerals, trees, etc)
    • Water rights
    • “Air space superadjacent to land”
  2. State law definitions of “real property” do NOT generally control whether an asset qualifies as “real property” for Section 1031 treatment.
  3. Any structural component to a permanent structure on improved land (e.g. a gas line that runs to a kitchen to fuel a burner) is not considered “real property” under Section 1031.
  4. Qualified intermediaries can distribute proceeds to acquire personal property  included in an exchange purchase that is incidental (i.e. typically transferred) to the real property provided that the fair market value of the incidental property is no greater than 15% of the real property.

We cover this topic (and much more!) in our FREE 1031 Exchange Guide

(Just click that link and enter your email)

2019-2020 Like-Kind Exchange Updates

Perhaps the most important 1031 exchange news of 2019 was the release of the IRS’ Second Round of Proposed Guidance on Opportunity Zones. This is welcome because, as those who follow “QOZ” know, the rules have been extremely vague.

These do not directly affect 1031 exchanges. That said, QOZ investments are a potential complement to (or even replacement for) 1031 strategies.

(Read more about 1031 exchanges vs. opportunity zones.)

Investors should follow proposed changes or clarifications on QOZ rules.

A few key takeaways

    • Qualified Opportunity Funds (QOFs) receive more latitude to invest in raw land, to lease property, and to dispose of one QOZ asset and reinvest in another.
    • The IRS defined “trade or business” in a way that likely excludes any triple-net (NNN) lease structures. This means QOFs should structure any lease arrangements to avoid NNN.
    • Both a QOF and a Qualified Opportunity Zone business (QOZB) can lease property, but the lease must be entered into after December 31, 2017 to count as a QOZ Business Property.
    • Safe harbors were provided to help QOZ Businesses navigate the “50% test” for business income.

Capital gains rates will not change between 2019 and 2020, but the brackets for the existing rates probably will. According to estimates from Bloomberg Tax, the maximum rates that tax filers can earn in 2020 and still qualify for the 15% capital gains bracket could be

    • $13,150 for trusts and estates
    • $441,450 for individuals
    • $496,600 for married couples filing jointly
    • $248,300 for married individuals filing separately

Tax Cut and Jobs Act of 2017: Impact for 1031 Exchanges

In 2017, President Trump signed the “Tax Cuts and Jobs Act” into law.

This slashed individual and corporate tax rates, increased deductions and credits, and attempted to crack down on loopholes and exemptions available to certain taxpayers — including investors attempting a like-kind 1031 exchange.

We can say “attempted” thanks to concerted efforts by major real estate lobbying groups (NAR and FEA among them) that managed to save the most important aspects of 1031 exchange regulations.

We did see some changes, as broken down below:

Prior to 2018, investors could exchange assets considered “personal property” by the IRS.

Examples included airplanes, collectables, works of art, livestock, franchise licenses, and classic cars. The new law only allows for “real property held for productive use or investment” to qualify for deferred exchange. In short, only real estate still qualifies.

The new tax law created incentives for investors to reinvest their proceeds into Opportunity Zones (OZ). Ideally, these OZs would bring economic development to historically struggling communities. Investors might be able to defer and, if certain conditions are met, exclude their capital gains taxes. Little guidance was given on OZs and their functionality.

While they do not interact with 1031 exchanges, some OZs can function as an alternative.

(Update: New regulations and revenue rulings issued on October 19, 2018 clarified many OZ details.)

Also modified were the allowable depreciation rules under IRC § 168(k). Under the new law, businesses could immediately deduct the full cost (100%) of many kinds of personal property; this amount drops by 20% per year after 2022 until it reaches 0% in 2027. This eases the loss of the personal property exchanges.

The standard property depreciation limits (27.5 years for residential; 39 years for nonresidential) remain unchanged. However, the alternative depreciation system for residential property changed from 40 years to 30 years.

Note: While much of the new tax reforms went into effect in 2018, some rules, such as the repeal of the individual mandate under the Affordable Care Act, did not become active until 2019.

Taxpayer Relief Act of 2012: Impact for 1031 Exchanges

The American Taxpayer Relief Act of 2012 changed the tax rate for long-term capital gains (effective in 2013) as applied to some taxpayers. It also coincided with a new healthcare tax (i.e. the “Obamacare surcharge”) applied to high-income earners.

Change in Capital Gains

    • The rate for long-term capital gains (and dividends) will remain at 15% for individual taxpayers with incomes of $400,000 or less ($450,000 for married taxpayers).
    • The rate for capital gains (and dividends) exceeding this level of income will rise to 20%.

Selling real estate at a large gain can easily push a taxpayer into a higher income tax bracket for that year. Of course, this increase in tax rate makes tax deferral under section 1031 even more valuable.

The new Medicare tax of 3.8%

In addition, as of 2013, the IRS imposes a Medicare tax of 3.8% on income (including capital gains from the sale of investment real estate) for” higher-income” taxpayers.

The income threshold for this tax are lower than the increased rates on capital gains explained above. Taxpayers with gross income of $200,000 ($250,000 for married taxpayers) will pay the new Medicare tax. This tax will only apply to the amount of gain which causes adjusted gross income to exceed this high-income threshold.

Moreover, two exceptions exist to this new tax:

    1. Real estate owned and used in a trade or business (as opposed to held for investment), and
    2. Real estate sold by real estate professionals. A real estate professional is a taxpayer who spends more than half of their year (and at least 750 hours) in real property businesses in which he or she materially participates.

Remember, a successful 1031 exchange also defers any Medicare tax. Taxpayers frequently underestimate the amount of tax they will be liable for when deciding not to 1031 exchange. Don’t forget to take into consideration the recaptured depreciation, state and local taxes, and now these new additional taxes.

1031 Exchange Rules Explained

1031 (or “like-kind”) tax exchanges allow taxpayers to defer payment on taxes when they sell investment or business property. The taxpayer must then reinvest into another investment or business property of equal or greater value.

Broadly speaking, investors owe two types of taxes after selling investment property.

  1. Capital Gain – Increase in value from the original purchase price.
  2. Depreciation Recapture – Recapture of depreciation expenses taken by the investor since acquiring the property.

Here is a little background:

Capital gains taxes were decoupled from ordinary tax rates following The Revenue Act of 1921. Suddenly, a window opened for treating gains made on investments differently than traditional income sources.

Section 202(c) of The Revenue Act of 1921 also created the first predecessors to modern 1031 exchanges, which allowed both like-kind and non-like-kind exchanges via a deferral strategy.

So began a nearly 100-year dance between investors and lawmakers about the necessity and merit of tax-deferred reinvestment.

Here are some common rules broken down below:

Bitcoin and Cryptocurrency Exchanges

In recent years, the IRS considered whether 1031 exchanges should apply to digital currency. The IRS already published guidance holding that Bitcoin and similar digital currencies will NOT be treated as currency for tax purposes. Instead, it considers Bitcoin and similar cryptocurrencies as personal property for tax purposes.

(Update) The latest tax reform bill eliminated personal property exchanges. Sadly, taxpayers may NOT use IRC § 1031 to defer capital gains on cryptocurrencies. At the moment, 1031 exchanges exist only for the reinvestment real property proceeds.

What is cryptocurrency?

A cryptocurrency is a digital asset designed to work as a method of exchange using cryptography to secure the transactions. Cryptocurrencies are classified as a subset of digital currencies and are also classified as a subset of alternative currencies and virtual currencies.

What is Bitcoin?

Bitcoin is a type of cryptocurrency that was created in 2009. It was the first decentralized cryptocurrency. Over the past 8 years, numerous new types of cryptocurrencies have been created. Bitcoin and all other types of cryptocurrency use decentralized control as opposed to centralized electronic money/centralized banking systems.

Capital Gains and cryptocurrency

If you sold cryptocurrency and realized a gain or loss, that needs to be declared on your tax return. Do not look for cryptocurrency platforms to send you a 1099.

If you sold your cryptocurrency within a year, any gain is treated as ordinary income. If you sold it after a year, it taxed as a capital gain (or loss).

What forms do I use?

Use Form 8949 to add it all up, and report it on Schedule D, along with other capital gains. Most accountants advise that you use FIFO (first in, first out) when calculating your gain (or loss).

What about trading one type of cryptocurrency for another?

Unfortunately, the Tax Cuts and Jobs Act of 2017 declared that cryptocurrency trades are not eligible for 1031 exchange treatment.