§1031 Exchange, Basic Statutory Requirements

The statutory requirements listed below relate to only to real estate transactions and are limited to basic provisions.  It is strongly advised that an investor contact appropriate legal and/or tax advisors before initiating a §1031 exchange.

There are three statutory requirements for a successful §1031 exchange:

  1. Exchange – the act of substituting one thing in return for another – reciprocal giving and receiving.
    1. Can be satisfied by a direct trade of properties (a swap of deeds)
    2. Can be satisfied using a Qualified Intermediary (QI) if the QI enters into an Exchange Agreement and assigns into real estate contract prior to transfer.
  2. Qualified Use – Both the Relinquished Property and the Replacement Property must be “held for” a qualified use, which can be either
    1. Investment property
    2. Property held for the productive use in a trade or business
  3. Disqualified Uses
    1. Not property held primarily for sale – (“Fix-N-Flips)
      1. That is inventory – gain taxes as ordinary income
      2. Focus on intent and actions
    2. Not dealer property (developer selling lots)
    3. Not primary residence or vacation (second) home
      1. Tax Court affirmed that the mere expectation of appreciation will not qualify a vacation home for §1031 exchange
    4. Conversion:  Properties can be converted from personal use to qualifying use and vice versa with careful planning.  IRS will look to intent of exchanger.  See IRC §280A.
  4. Like-Kind Property – Refers to the nature or character of the property, not to its grade or quality.  Real property is not like-kind to personal property.  State law generally determines whether property is real or personal.
    1. Real Property:  The requirement for real property is very broad.  The following types of property are all considered like-kind and can be exchanged for each other:  Vacant land; commercial buildings; ranches; rental homes; apartments; tenancy-in-common interests; and easements and leases of 30 years or more (including options).

Three rules for a fully tax deferred exchange:

Replacement property must have:

  1. Purchase Price – A purchase price greater or equal to the net sales price of the relinquished property
    • Buy equal or greater in value
  2. Net Equity – Net equity greater or equal than the equity in the relinquished property
    • Spend all of the equity
  3. Debt – Debt greater to or equal than the debt on the relinquished property
    • Owe as much or more on purchase

Boot:  Any non-like-kind property received (usually in the form of cash, an installment note, debt relief or personal property) will be taxes as “boot”, up to the amount of realized gain.

Partially Tax Deferred Exchange:  Can be a partial exchange where the Exchanger receives like-kind property and boot.

Notice:  Peak Realty Advisors, a professional real estate brokerage affiliates with and recommends experts, each with specialties in associated areas including, qualified intermediary, legal, tax, funding, and escrow, all companies proven to serve as your resources to obtain accurate and thorough information about the entire exchange process.

§1031 Exchange, What is it
§1031 Exchange Terminology
§1031 Exchange Process Checklist

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