What is a 1031 Exchange?  

In the summer of 1990, the I.R.S. finally came out with the long awaited rules on Deferred Exchanges. Section 1.1031 (IRC §1031) of the Internal Revenue Code laid out in detail the procedure for turning a sale and purchase type transaction into an exchange.

IRC §1031 (a)(1) 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."

These new rules allow owners of certain types of like kind Real and Personal property to sell their property and buy other like kind property without paying the Capital Gains Tax.

To understand the powerful protection an exchange offers, consider the following example:

• An investor has a $200,000 capital gain and incurs a tax liability of approximately $70,000 in combined taxes (depreciation recapture, federal and state capital gain taxes) when the property is sold. Only $130,000 remains to reinvest in another property.
• Assuming a 25% down payment and a 75% loan-to-value ratio, the seller would only be able to purchase a $520,000 new property.
• If the same investor chose to exchange, however, he or she would be able to reinvest the entire $200,000 of equity in the purchase of $800,000 in real estate, assuming the same down payment and loan-to-value ratios.

The like kind provision for Real property is quite broad, and includes Land, Rental, and Business property. Any of which, can be exchanged for the other.

The like kind provision for Personal property is more restrictive.  This type of property must be in productive use in a business (depreciable property), and can only be exchanged for the same type of property.

An example would be: a business aircraft for a business aircraft (a fixed wing airplane for a helicopter will work), or a commercial truck for a commercial truck, etc.

The rule also requires that the "Exchanger" use a safe harbor to hold the proceeds while the exchange was in progress (and spelled out what those safe harbors are) and that the "Exchanger" be held to certain time limits and other requirements.

If you have any questions regarding a 1031 Excange, please contact us or call a local tax attorney.

POTENTIAL "LIKE-KIND" PROPERTY EXCHANGES AND BENEFITS:

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