Section 1031 is a provision in the tax code that many real estate property owners can benefit from. As you probably already know, the 1031 exchange makes it possible for you to buy and sell real estate properties while deferring the tax consequence of these transactions. But there are also 1031 exchange rules that have been set up by the government so that this provision will not be abused. In line with this, here are the basic 1031 property exchange rules you need to be aware of:
It must be a qualified property
The property can become a qualifying property for the 1031 exchange law if it was held for investment or business reasons. Some real estate properties that can be considered for the 1031 exchange rule include properties that are either improved or unimproved, properties that are held for income-producing endeavors, and/or properties that are used for the investor’s trade or business.
Replacement property must have the same owner
This provision means that the title holder of the relinquished property must be the same as that of the replacement property. So if a husband and wife hold the relinquished property jointly, both of their names should be used as title holders of the replacement property. Even corporations and partnerships should follow this rule.
1031 is limited to like-kind properties
Many people are confused by this like-kind provision, but the concept behind it is actually quite simple. For example, an unimproved property can be replaced by an unimproved property, two separate properties can be replaced with a single real estate property, and a four-plex can be exchanged with a duplex. So where does the like-kind fit into all these? As you can see, investment properties can be replaced with business properties and the other way around. The like-kind provision here simply means that a business property cannot be replaced with a residential property and vice versa but other than that, any property exchange using the 1031 provision is possible.
Boot received will be taxable
The “boot” in this case is used to describe the tax consequence that an investor may incur in case there is an excess value he received from the exchange of his property. The boot includes all cash equivalents of and the liabilities that were assumed by the investor that were taken by the other party. Basically, boot has something to do with the fair market value of the properties that are being exchanged. You can avoid paying the “boot” though. The basic strategy to avoid paying this is always to trade up. This means that you have to exchange your property with something that is of equal or greater value compared to your relinquished property.
Conclusion
As you can see, there are some limitations you have to deal with when you want to take advantage of the benefits of the 1031 exchange provision. But following all these rules will be worth it in the long run because you will be able to enjoy getting a new property without having to pay any bothersome tax.
