Frequently Asked Questions:
    What is IRC § 1031?
    What is like kind property?
    Does an exchange need to be simultaneous?
    When is an exchange applicable?
    What are the requirements?
    What is boot?
    Do vacation homes qualify?
    A brief analysis

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What is IRC § 1031?

Section 1031 of the Internal Revenue Code allows an owner of investment property to exchange property and defer paying federal and state capital gain taxes (20% + applicable state taxes) if they purchase a “like-kind” property following the rules and regulations of the Internal Revenue Code. This allows investors to use all of their proceeds from their sale to leverage into more valuable real estate, increase cash flow, diversify into other properties, reduce management or consolidate into one property.

 

What is “like-kind” property?

There is some confusion regarding what type of property qualifies for a §1031 tax deferred exchange. The Internal Revenue Code Section 1031 states: “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.” Like-kind property can include, but is not limited to, any of the following, provided it is for investment:

• Single Family Rental

• Duplex

• Apartment

• Commercial Property

• Raw Land

For example, a single-family rental can be exchanged for raw land, or apartments or a commercial building. In addition, properties can be exchanged anywhere within the United States.

Does a §1031 exchange need to be simultaneous?

No, contrary to what most owners envision, a §1031 tax deferred exchange is rarely a two-party swap. Most exchanges are delayed exchanges, whereby the Exchanger has 180 days between the sale of the relinquished property and the closing of their replacement property. They must identify the potential replacement property or properties within 45 days from closing on their relinquished property.

When is a §1031 exchange applicable?

It is applicable whenever a property owner intends to sell any property that is not their primary residence (and falls under the definition of “like-kind”) and plans to BUY another “like-kind” property within 180 calendar days following the closing of their relinquished property.

What are the requirements for full tax deferral
in an IRC §1031 exchange?

If an Exchanger intends to perform an exchange that is fully tax deferred, they must meet two simple requirements:

• Reinvest the entire net equity (net proceeds) in one
  or more replacement properties; AND

• Acquire one or more replacement properties with the
  same or a greater amount of debt.

An alternative approach for complete tax deferral is acquiring property of equal or greater value and spending the entire net equity in the acquisition. One exception to the second requirement is that an Exchanger can offset a reduction in debt by adding cash (“boot”) to the replacement property closing.

What is "Boot "?

The term “boot” refers to any property received in an exchange that is not considered “like-kind.” Cash boot refers to the receipt of cash. Mortgage boot (also called “debt relief”) is a term describing an Exchanger’s reduction in mortgage liabilities on replacement property. Any personal property received is also considered boot in a real property exchange transaction.

If the Exchanger receives cash or other property in addition to like-kind property, this may result in a taxable event. To determine the taxes that may be due, several steps are required.

First, the Exchanger’s tax advisor must calculate the realized capital gain. Second, the amount of “boot,” money or other property received, along with any depreciation recapture, must be determined. Finally, a tax advisor will review the Exchanger’s specific situation to see if there are additional tax issues that may offset any current capital gain tax liabilities.

Do vacation homes qualify for tax deferral under §1031?

Property owners throughout the nation are obtaining the benefit of full reinvestment of equity under Internal Revenue Code §1031.  Many investors exchange out of a single-family rental, duplex, or other type of investment property and into a vacation/second home.  Many tax and legal advisors believe it is possible to perform an exchange on a vacation property that has no rental history but which still can be considered "held for investment."

Support for vacation home exchanges?

In Private Letter Ruling (PLR) 8103117, the IRS did allow for tax deferral when a property owner intended to acquire property for personal enjoyment and as an investment.  As stated in this PLR, “...the house and lot you acquire in this trade will be held for the same purposes as the properties exchanged: to provide for personal enjoyment and to make a sound real estate investment.” Although a PLR only applies to the facts and circumstances in a particular individual's specific situation, it appears, in this instance, that "personal enjoyment" of a property does not prevent a property owner from benefiting from a tax-deferred exchange.

Each individual case must be reviewed

Note:    There are no regulations, statutes, or court cases in which a definitive answer is given on the exchange of vacation/second.  Each exchange must be reviewed on a case-by-case basis.  To qualify for an exchange, the property owner should be able to support that the property is "held for investment."

A brief analysis