This article is part 1 of a three-part series regarding 1031 Exchanges.
Are you in a position to sell investment real estate at a profit but want to remain in the real estate game? Would taking advantage of an oft-unknown IRS Code Section to defer gains from the original sale of real property be of interest? Assuming your answer is “yes”, our Firm has recently completed multiple transactions to accomplish just this result.
A “1031 Exchange” enables an owner (“Exchanger”) of real property held for productive use in a trade or business or for investment purposes to defer capital gains tax and depreciation recapture by reinvesting proceeds from the sale of said property into other qualified “like-kind” property. Internal Revenue Code Section 1031 and associated Treasury Regulations (the “Code”), impose strict requirements for a successful 1031 Exchange, but the benefits in tax deferral are obvious, especially if the real property being sold has a low basis.
This leads to the obvious question: what is qualified like-kind property? Perhaps surprisingly, the IRS has taken a very broad view of what qualifies as like-kind property. As used in the Code, the words like-kind refer to the character or nature of the property and not to its grade or quality. Therefore, improved real property may be exchanged for unimproved real property and vice-versa, as, whether the real property is improved or not refers to its grade or quality and not the character or nature of the property.
Essentially the IRS has taken the position that all real property is like-kind to all other real property. Residential, commercial, industrial, or retail rental properties may be exchanged for other real property. Furthermore, just about any interest in real property, not just fee simple title, qualifies. For example, oil and gas royalties may be exchanged for a fee simple interest in a parcel of land and a fee simple interest in land may be exchanged for a leasehold interest.
What really matters is the owner’s purpose and intent in holding the property. So long as the Exchanger has held the property being disposed of (the “Relinquished Property”) for productive use in a trade or business or for investment purposes AND intends to hold the property being received (the “Replacement Property”) for productive use in a trade or business or for investment purposes, then the two properties are of like-kind for purposes of the Code.
However, the Code expressly states that real property held primarily for the purpose of sale is NOT qualified like-kind property. This exception to the tax deferral benefits offered by the Code is intended to preclude dealers and developers from benefitting in the normal operations of their business.
When the time comes to upgrade your facilities or exchange one piece of investment property for another, please contact your WHP counsel to determine if a 1031 Exchange would be right for you.
We invite you to read other articles in this three-part series:
This article provides an overview and summary of the matters described therein. It is not intended to be and should not be construed as legal advice on the particular subject.