To be eligible for IRC 1031, the exchanged properties must be held for efficient use in a business or trade, or for investment. Before 2018, other properties, bonds, and stocks were listed as expressly barred by Section 1031 of the Internal Revenue Code, however securitized properties were permitted. At present only real property is allowed under IRC 1031. The properties swapped must be of “like kind,” i.e., of the same character or nature, even if they vary in quality or grade. Under the pre-2018 provisions personal properties of a similar class were like-kind properties.
What is a Like-Kind property?
Real properties generally are of like kind, indifferent of whether the properties are unimproved or improved. However, a real property located in the United States and a real property located outside the United States would not be considered like-kind properties. Ideally, “like kind” in terms of real estate, indicates any property that is listed real estate in any of the fifty U.S. states or Washington, D.C., and in few cases, the U.S. Virgin Islands.
A Qualified Intermediary is needed to facilitate the transaction, by retaining all the gains of a sale, and then disbursing those gains at the closing, or sometimes for fees linked with acquiring the new property.
What is Boot/Gain?
Cash to adjust a transaction cannot be deferred under IRC 1031 because money is not of like kind. This cash is referred to as “boot” and the gain, to the degree of the receipt of this cash, taxed at a standard capital gains rate.
Initially, 1031 cases required to be concurrent transfers of ownership. But after the rendering of the verdict in Starker v. the United States, a contract to exchange properties in the future is identical to a simultaneous transfer. This case developed the concept of the Starker exchange. Starker Exchange paved the way for the origin of the rules for the election of a delayed 1031. To elect the 1031 recognition, the property needs to be identified by the taxpayer before closing. Investors get 45 days to identify the replacement property and 180 days of closing to acquire the replacement property.
Taxpayers who own real estate as inventory, or who buy real estate for resale, are considered “dealers.” These properties are ineligible for Section 1031 exchange . However, if a taxpayer is an investor and a dealer, he or she can utilize Section 1031 on qualifying properties. Properties used for personal purposes are not eligible for 1031 exchange .