10 Things you Need to Know about 1031 Exchanges – Forbes.com
Tax nerds may be able to spout off Internal Revenue Code Sections, but most people never get beyond 401(k). (That’s right, your workplace retirement savings plan is named after a section of the tax code.)
Still, “Section 1031″ is slowly making its way into daily conversation, bandied about by realtors, title companies, investors and soccer moms. Some people even insist on making it into a verb, a la FedEx , as in: “Let’s 1031 that building for another.” (While Section 1031 isn’t restricted to real estate, that’s clearly where most of the discussion takes place.)
So what is 1031? Broadly stated, a 1031 exchange (also called a like-kind exchange or a Starker) is a swap of one business or investment asset for another. Although most swaps are taxable as sales, if you come within 1031, you’ll either have no tax or limited tax due at the time of the exchange.
Such complications are why you need professional help when you’re doing a 1031. Still, if you’re considering a 1031–or just curious–here are 10 things you should know.
1. A 1031 isn’t for personal use.
The provision is only for investment and business property, so you can’t swap your primary residence for another home. There are ways you can use a 1031 for swapping vacation homes, but this loophole is much narrower than it used to be. For more details, see No. 10.
2. But some personal property qualifies.
Most 1031 exchanges are of real estate. However, some exchanges of personal property (say a painting) can qualify. Note, however, that exchanges of corporate stock or partnership interests don’t qualify. On the other hand, interests as a tenant in common (sometimes called TICs) in real estate do.
3. “Like-kind” is broad.
Most exchanges must merely be of “like-kind”–an enigmatic phrase that doesn’t mean what you think it means. You can exchange an apartment building for raw land, or a ranch for a strip mall. The rules are surprisingly liberal. You can even exchange one business for another. But again, there are traps for the unwary.
4. You can do a “delayed” exchange.
Classically, an exchange involves a simple swap of one property for another between two people. But the odds of finding someone with the exact property you want who wants the exact property you have are slim. For that reason the vast majority of exchanges are delayed, three party, or Starker exchanges (named for the first tax case that allowed them). In a delayed exchange, you need a middleman who holds the cash after you “sell” your property and uses it to “buy” the replacement property for you. This three party exchange is treated as a swap.
5. You must designate replacement property.
There are two key timing rules you must observe in a delayed exchange. The first relates to the designation of replacement property. Once the sale of your property occurs, the intermediary will receive the cash. You can’t receive the cash or it will spoil the 1031 treatment. Also, within 45 days of the sale of your property you must designate replacement property in writing to the intermediary, specifying the property you want to acquire.