– Guide for Real Estate Investors –
This post covers the basic 1031 exchange rules and regulations set forth by the IRS, the IRC, and various tax courts. If you have questions about terminology or can’t find an answer below, Contact our staff directly , or try one of the resources below:
Eligible properties for a 1031x
Both the relinquished property and the replacement property must be held for a “qualified purpose.” In other words, any 1031 property must be (A) used for investment or (B) used in trade or business.
If you hear industry lingo about “like-kind” properties, this is what it means.
You can, for example, sell a ranch and 1031x into a mobile home park. Or, you can sell a conservation easement and buy an oil well. The IRS does not distinguish between “commercial” or “residential” investment property.
This flexibility makes 1031 exchanges a very powerful investment tool.
Also, you can exchange multiple relinquished properties for one replacement property or vice versa.
You may also sell 100% of the relinquished property and buy only 5% (for instance) of the replacement property. This rule creates interesting possibilities. You might sell 100% of a small property and buy a small percentage of a larger property with other like-minded investors (as tenants in common).
Gray areas: vacation homes and homes occupied by relatives. Note that dual-use properties — that is, properties which you occupy as your principal residence and also hold for investment — usually qualify for 1031 exchange treatment on the portion held for investment.
Eligible locations for a 1031x
You can exchange property in one state for property in another state.
Be warned, some states do not recognize 1031 exchange with regard to state income taxes (e.g. Pennsylvania), while other states will impose a tax if an out of state 1031 replacement property is ultimately sold in a taxable transfer (e.g. California).
You may NOT exchange foreign real property into a domestic property (or vice versa).
Why Qualified Intermediaries play an Important Role
You need a neutral, third-party qualified intermediary (“QI” or “accommodator”) to help you perform a successful 1031 exchange.
Why? Because the IRS says so. [See Treasury Regulation §1031.1031(k)-1(g)(4)(iii)]
It is the QI’s job to help you explain, coordinate, and execute the 1031 process. You’ll sign an agreement with your QI that limits your rights to “receive, pledge, borrow, or otherwise obtain benefits of money or other property” held during the 1031 exchange.
Just as critically, your QI should help you set up a secure escrow account. This is where your exchange proceeds stay after you sell the relinquished property.
When you are ready to close on your replacement, the QI ensures that the proceeds arrive safely and on time.
1031x.com, Inc. is a trusted qualified intermediary with more than 25 years experience. We provide all services in accordance with the Internal Revenue Code and the Treasury Regulations.
Our company is a proud member of the Federation of Exchange Accommodators (FEA).
What happens to tax basis in a 1031 exchange?
The basis of the relinquished property will carry forward into the replacement property.
TIP: The easiest way to calculate the basis in the replacement property is to start with its purchase price, then reduce this number by the amount of gain deferred in the 1031 exchange.
We’ve only covered the very basic 1031 exchange rules here. Each exchanger’s circumstances are different; your circumstances may not qualify for tax deferral or may require additional strategies.