What
is a 1031 Tax-Deferred Exchange?
The 1031 tax-deferred exchange (as
permitted by §1031
of the Internal Revenue Code) is a way for a property owner
to exchange prior owned property for new property without incurring
income tax on the gain - a tax deferred exchange. This transaction
represents substantial savings for the property owner. Pioneer
Title can act as the Qualified Intermediary in these types
of transactions.
The
most common transaction is a delayed exchange: Under this scenario,
Pioneer Title, through "Independent
Trustees", an affiliated company, holds the proceeds
from the sale of the first property for the benefit of the
client, until a second property is identified as replacement
property. Proceeds from the sale of the first property are
deposited into an interest bearing account, where the client
receives interest on deposited funds at competitive rates of
return. Pioneer then forwards the proceeds (including interest)
for the purchase of the replacement property, at the time of
the second closing.
When
a taxpayer participates in an IRS Section 1031 tax-deferred
exchange, he is required to exchange his business or investment
property for “like kind” property. If he is exchanging
real property the definition of “like kind” is
very broad. All real property is “like kind” to
all other real property. This definition refers to how the
property is held by the investor, not the type or character
of the property. The following are examples of like kind exchanges:
•
Residential for commercial
• Bank building for swamp land
•
Raw land for residential
• Fee simple interest for 30-year leasehold
• Single family rental for multi-family rental
• Non-income producing for income producing
• Rental mountain cabin for a dental office in which the exchanger intends
to practice
The exchanger must hold the relinquished
property for investment or for "productive use in his
trade or business" to qualify for §1031 treatment.
The critical issue here is the exchanger's purpose in holding
the property-how he intends to use the property- rather than
the type of property.
The following are examples of qualifying properties:
Bare
land
Commercial rental
Industrial property
30-year leasehold interest
|
Farmer's farm
Residential rental
Doctor's own office
Percentage interest in investment property |
The intent to hold the property for personal
use will prevent the property from qualifying for §1031
treatment. Therefore, second homes will not qualify
for §1031 treatment unless the property owner changes
how he treats or uses the second home. For example,
a taxpayer could "convert" his second home to a
valid exchange property and establish this intent by properly
renting the property and holding it as a legitimate rental
property. Consultation with a tax advisor is important whenever
a taxpayer changes how he intends to hold property.
The intent to hold property "primarily
for sale" will prevent the property from qualifying
for § 1031 treatment. Most properties owned by developers,
builders and people who perform rehabilitation work are held
primarily for sale and may not be the subject of an exchange.
When these properties are sold, they are subject to ordinary
income taxes rather than capital gain taxes. Partnership interests, notes secured by real
property, contract vendor's interests, and foreign property
(under the Revenue Reconciliation Act of 1989) do not
qualify for §1031 treatment. |
