Cashing Out: Section 1031 Exchanges to Defer Tax on Sales
Filing Guide
Use Form 8824 to report like-kind exchanges, along with any cash or “net mortgage relief” boot. If you give up boot in the exchange, report it as a loss and carry that amount to Schedule D.
IRS Publication 544:
Sales and Other
Dispositions of Assets
Tax Savers
In 2002, the IRS established conditions to qualify “tenancy in common” interests (TICs)—pieces of larger properties, such as office parks, shopping centers, or apartment complexes—for 1031 exchanges. Now you can swap day-to-day management for a regular income payable by the TIC sponsor. This may be attractive if you’d like to retire from active management without giving up section 1031 tax advantages.8
Land Mines
You can use Section 1031 to transfer real estate to a related party: a spouse, sibling, parent, child, or corporation or partnership you directly or indirectly own more than 50%. That related party has to hold the property at least two years or the exchange will be disallowed and you’ll be taxed on the gain as of the date the related party transfers the property.9
Land Mines
If you convert a replacement property into your principal residence, you'll have to recapture any depreciation as of the date you convert the property to residential use. You'll also have to wait at least five years (rather than the typical two) to exclude any gain from your income under the principal residence rules.10
Sources
1Regs. §1.1031(a)-1(b).
2Regs. §1.1031(b)-2.
3Regs.
§1.1031(d)-2.
4IRC §1031(b).
5IRC §1031(a)(3); Regs. 1.1031(k)-1.
6Rev. Rul. 2000-37.
7Rev.
Rul. 2000-37.
8Rev. Rul. 2002-22.
9IRC §1031(f).
10IRC
§121(d); Rev. Proc. 2005-14.
“Section 1031” exchanges let you relinquish property you hold for trade or business use or for investment tax-free for a “like-kind” replacement. You can trade up, relocate, diversify, or consolidate properties and defer tax on recaptured depreciation or capital gains until you sell the replacement. You can exchange properties as many times as you like for nearly unlimited tax deferral. Here’s how it works:
- “Like-kind” is defined by use, not character. You can trade raw land for developed acreage, residential property for nonresidential property, and even fee-simple ownership for leaseholds of 30 years or longer.1
- You’ll need a qualified intermediary to arrange paperwork and hold sale proceeds to avoid actual receipt, which would trigger immediate tax.2
- You need to roll all of the proceeds from your relinquished property into buying your replacement. The purchase price and mortgage on the replacement must be equal or greater than that of the original.3
- If you receive cash, nonlike-kind property, or mortgage relief (“boot”) in the exchange, the value of that boot is taxable.4 (You can combine a 1031 exchange with an installment sale, private annuity, or private annuity trust to defer tax on boot.)
You don’t have to trade one property directly for another. You can relinquish a property, take proceeds in escrow, and roll the proceeds into your replacement. You don’t even have to close both properties simultaneously. Consider these possibilities:
- “Deferred” exchanges involve selling before you find your replacement. You have up to 45 days from the date you relinquish your original property to identify up to three potential replacements. You have up to 135 days more (or until the due date, including extensions, for filing your return for the year in which you transfer the relinquished property) to actually close your replacement.5
- “Reverse” exchanges let you buy your replacement property up to 180 days before you sell your existing property. You’ll need an accommodation titleholder (“AT”) to hold title to the replacement property; however, you can guarantee loans for the AT, loan or advance cash to the AT, and rent, lease, or manage the property while held by the AT.6
- “Improvement” and “build to suit” exchanges let you sell one property and roll the gain into improving another property that you already own.7
| Prepared using the templates at Tax Coach Software |