A 1031 exchange can be a viable strategy for deferring capital gains taxes when you sell your real estate used for trade or investment and use the proceeds to purchase a like-kind property. When conducted correctly, the like-kind exchange process can help build wealth and diversify your real estate holdings.
But can a 1031 exchange be used to acquire life insurance? The answer is no.
Rules of a 1031 Exchange
The IRS has multiple rules regarding the like-kind exchange. These include stringent deadlines, the requirement of using a Qualified Intermediary (QI), and the type of assets eligible for exchange.
At one time, using multiple capital assets for 1031 exchanges was possible. However, these rules changed with the passage of the Tax Cuts and Jobs Act of 2017. This bill eliminated using any non-real estate asset in a like-kind exchange.
In fact, “like-kind” means “the same.” It also means that only investment or business real estate can be exchanged for other real estate with the same uses.
Life Insurance versus Real Estate
Life insurance and investment real estate could be considered capital assets. But only real estate is eligible as a replacement property within a 1031 exchange. Here’s why:
- Life insurance isn’t real estate. The IRS’ like-kind rule means that relinquished and replacement assets must be similar in nature or character. Real estate is defined as land and permanent structures. Life insurance is a financial product. These aren’t like-kind assets.
- Only real estate is eligible. As mentioned above, the only assets eligible for a 1031 exchange are investment or business real estate. You can’t exchange your property for a life insurance policy in an attempt to defer taxes.
Additionally, different tax treatments apply to life insurance and investment real estate. Life insurance provides tax-deferred growth of cash value and a tax-free death benefit to the named heirs and beneficiaries.
Investment real estate almost always involves taxes, especially when the asset is sold. The 1031 exchange can help defer—not delete—capital gains and depreciation taxes in this situation.
Capital Assets Aren’t the Same
While a 1031 exchange can provide a tax-advantaged strategy for real estate transactions, it can’t be used to invest in life insurance directly without being a taxable event. The IRS limits 1031 exchanges to like-kind real estate properties, excluding financial products like life insurance policies.
However, you could rely on creative strategies—including 1031 exchanges and life insurance—in your wealth-building and legacy plans. Consult with experienced tax advisors, financial planners and real estate professionals when considering various investment strategies.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
