26 U.S. Code § 1031—“Exchange of Real Property Held for Productive Use or Investment”—can help delay capital gains tax payments from selling your real estate. The 1031 exchange, also called the “like-kind” exchange, lets you invest those gains into other real estate of greater or equal value.
However, certain property types might not qualify for this tax-deferral strategy.
The 1031 exchange is only valid for real estate held for investment or business purposes. This means your home isn’t eligible as long as it’s your primary residence. Your vacation home isn’t qualified, either.
The only exception is if you rent these properties or they are for mixed-use. Even so, the properties must meet specific criteria to be considered eligible for a like-kind exchange.
Investment or business-use real estate in the United States can be exchanged for like-kind real estate in all 50 states, Washington D.C. Guam, and the Northern Mariana Islands.
However, properties located in Puerto Rico, the U.S. Virgin Islands, American Samoa, or foreign countries are not eligible for 1031 exchanges with U.S. real estate.
Buying a property, renovating and reselling it immediately could be considered an investment. This might be true, but this property type isn’t eligible for a like-kind exchange.
For one thing, the IRS considers flipped properties as “stock in trade” or “held primarily for sale.” Specifically, the IRS considers this property type as inventory, which isn’t qualified under 1031 exchange rules.
Furthermore, most flips are intended for a quick profit rather than a long-term investment, which can contradict the purpose of a like-kind exchange.
Like flipped property, real estate held specifically for sale or trade doesn’t qualify for a like-kind exchange. The IRS classifies this real estate as inventory that doesn’t qualify for tax deferral under Section 1031.
The 1031 exchange can be a viable way to defer capital gains taxes on the sale of investment or business-use real estate. But not all real estate—or individuals involved—might be eligible. Furthermore, noncompliance with like-kind exchange rules can also disqualify a property.
To learn more about what assets qualify for this tax-deferral treatment—and to get the most from it if your property is eligible—be sure to partner with tax advisors, real estate lawyers, and other professionals who have experience with the topic and its process. Doing so helps you build and maintain a viable real estate investment strategy.
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.