Definition
An exchange, specifically under Section 1031 of the Internal Revenue Code (IRC), allows for the tax-deferred exchange of like-kind properties used in a trade or business or held as an investment. This tax-deferral provision enables taxpayers to delay paying capital gains taxes on an investment property when it is sold, as long as another comparable property is purchased with the profit gained by selling the first.
Examples
- Example 1: Collins exchanges her farm worth $1,000,000, but subject to a $200,000 mortgage, for Baker’s apartments worth $800,000 that are free and clear of debt.
- Example 2: A commercial property owner exchanges an office building worth $2,000,000 for a similarly valued retail shopping center, allowing the property owner to defer the capital gains tax on the office building.
- Example 3: An investor exchanges an undeveloped piece of land worth $500,000 for a multi-family rental property to enhance the investment portfolio without immediately incurring tax liability.
Frequently Asked Questions
What qualifies as like-kind property?
Like-kind property refers to real estate of the same nature or character, even if they differ in grade or quality. Calculating what qualifies can be complex, often requiring professional advice.
What is Boot in the context of a 1031 exchange?
Boot refers to any additional value received in an exchange that is not considered like-kind property, such as cash, personal property, or reduced mortgage liabilities. Boot is taxable to the extent of gain recognized.
Can personal residences qualify for a 1031 exchange?
No, personal residence properties do not qualify for a 1031 exchange. The exchange must involve properties used in trade, business, or an investment.
What is a Delayed Exchange?
A delayed exchange, also known as a Starker exchange, involves selling property and acquiring the replacement property at a later time, within 180 days after the sale of the first property.
What is a Reverse Exchange?
A reverse exchange occurs when the replacement property is acquired before the sale of the relinquished property. A qualified intermediary typically holds the replacement property until the original property is sold.
Related Terms with Definitions
- Boot: Additional value received in an exchange that is not like-kind property. It can make the transaction partially taxable.
- Realized Gain: The gain computed based on the difference between the selling price and the initial purchase price of an asset.
- Recognized Gain: The portion of the realized gain subject to taxation.
- Starker Exchange: Another term for a delayed exchange, involving the deferred acquisition of a replacement property.
- Delayed (Tax-Free) Exchange: An exchange where the replacement property is acquired after the initial property is sold, within a specified timeframe.
- Reverse Exchange: An exchange where the replacement property is acquired before the sale of the relinquished property.
Online Resources
- IRS - Like-Kind Exchanges Under IRC Section 1031: Link
- National Association of Realtors (NAR) - 1031 Like-Kind Exchange: Link
- Federation of Exchange Accommodators (FEA): Link
References
- Internal Revenue Service. “Publication 544 (2019), Sales and Other Dispositions of Assets.” IRS. Link
- National Association of Realtors. “Tax Reform.” NAR. Link
- National Association of Realtors. “Like-Kind Exchanges.” NAR.
Suggested Books for Further Studies
- “Real Estate Exchange Strategies Using Sections 1031 and 1033 (REI Deskbook)” by A. Gilbert Lund III
- “Exchanging UP! 1031 Exchange Mastery for Real Estate Investors and Agents” by Timothy Leigh
- “The 1031 Exchange Handbook” by Jennifer G. Mall
Real Estate Basics: Exchange Fundamentals Quiz
Interactive quizzes related to the topic: Exchange
### Does a personal home qualify for a 1031 exchange?
- [ ] Yes, any real estate qualifies.
- [ ] Yes, but only if it is the principal residence.
- [ ] No, but second homes qualify.
- [x] No, only property used in trade or business and held for investment.
> **Explanation:** Personal residences do not qualify for a 1031 exchange. The properties involved need to be used in the trade or business or held as investments.
### What constitutes "Boot" in a 1031 exchange?
- [x] Any additional value received that is not like-kind, such as cash, personal property.
- [ ] Solely cash.
- [ ] Only properties of a lower value.
- [ ] Exchange fees.
> **Explanation:** Boot is any value received in an exchange that is not considered like-kind property. This can include cash, mortgage reductions, or other additional value items and is subject to taxation.
### How many days does a property owner have to identify a new property after selling the original one in a delayed exchange?
- [ ] 30 days.
- [x] 45 days.
- [ ] 60 days.
- [ ] 90 days.
> **Explanation:** In a delayed exchange, property owners have 45 days from the sale of their property to identify the replacement property they intend to acquire.
### Over what timeframe must the newly identified like-kind property transaction be completed in a delayed exchange?
- [ ] 90 days.
- [ ] 120 days.
- [ ] 150 days.
- [x] 180 days.
> **Explanation:** The newly identified property must be acquired within 180 days to comply with the regulations for a delayed exchange.
### What type of exchange involves purchasing the replacement property before selling the relinquished one?
- [ ] Delayed Exchange.
- [ ] Timeline-deferral exchange.
- [ ] Simultaneous Exchange.
- [x] Reverse Exchange.
> **Explanation:** A reverse exchange involves acquiring the replacement property before the older property is sold, often using a qualified intermediary to hold the replacement property.
### Is a qualified intermediary required in a 1031 exchange?
- [x] Yes, to facilitate the exchange and ensure compliance.
- [ ] No, but it’s recommended.
- [ ] Only for reverse exchanges.
- [ ] Only for high-value properties.
> **Explanation:** A qualified intermediary is required to facilitate the exchange process and ensure that all IRS regulations are met, thus maintaining the tax-deferred status of the transaction.
### Can you exchange a single-family rental home for office space in a 1031 exchange?
- [x] Yes, since both are income-producing properties, they qualify.
- [ ] No, they must be of the same type.
- [ ] Only if they are of equal value.
- [ ] Only if located in the same region.
> **Explanation:** As long as both properties are income-producing, they qualify for a 1031 exchange even though they serve different commercial purposes.
### What taxation term describes the total gain from the sale of an asset before accounting for any tax deferrals?
- [ ] Recognized gain.
- [ ] Computed gain.
- [x] Realized gain.
- [ ] Deducted gain.
> **Explanation:** Realized gain is the total gain calculated from the sale of an asset before taking into account various deferrals, such as those under a 1031 exchange.
### What type of property can disqualify the use of a 1031 exchange if included in the transaction?
- [ ] Business-use property.
- [ ] Investment property.
- [ ] Like-kind property.
- [x] Personal-use property.
> **Explanation:** Inclusion of personal-use property in a transaction disqualifies it from being a tax-deferred like-kind exchange.
### Does mortgage relief qualify as "Boot" in a 1031 exchange?
- [x] Yes, and it is taxable.
- [ ] No, it is not considered additional value.
- [ ] Only when below certain thresholds.
- [ ] Only if both properties are mortgaged.
> **Explanation:** Mortgage relief is considered boot in a 1031 exchange, representing additional received value, and is taxable to the extent of the gain recognized.
