A Primer on a 1031 Realestate Exchange

The 1031 realestate exchange is popular because it allows taxpayers to dispose of certain real or personal property and defer their federal, and in most cases, state income tax liability by exchanging the real or personal property (relinquished property) for qualified use like-kind property (replacement property). But investors should remain aware that the transaction is governed by IRS rules and regulations. To use this technique you must become a student of the concept.

A good first course is to have basic understanding of the rules for a 1031 realestate exchange. A good place to start is by knowing the different types of like-kind exchanges:

A simultaneous exchange occurs when the exchange (disposition) of the relinquished property (sale property) and the purchase of the like-kind replacement property occurs at the same time. The delayed exchange, the most common form of exchange, occurs when there is a time delay between the transfer (conveyance) of the relinquished property (sale property) and the purchase of the like-kind replacement property. This type of exchange is subject to time limits set by the Department of Treasury.

When the like-kind replacement property is purchased first, prior to transferring (conveying or selling) the relinquished property to the actual buyer, it is called a reverse exchange. Built-to-suit exchange refers to the technique of allowing the taxpayer to build on, or make improvements to, the like-kind replacement property, using the exchange proceeds before they actually take title to the property. And finally, the personal property exchange occurs when personal property is exchanged for other personal property of like-kind or like-class as long as the personal property has been held for investment, income production (rental) or use in a business.

Also, knowing the types of property that can be exchanged under a 1031 will help property owners find replacement properties in a changing market place. Qualifying use property is property that has been or will be held for income production (rental), investment or used in a trade or business. Your personal residence and vacation home are not qualifying use property and thus do not qualify for 1031 realestate exchange treatment. Assuming the property satisfies the qualified use test, then the property must also satisfy the like-kind test. Real property is like-kind to real property, so as long as you are exchanging real property for real property it will qualify as like-kind for 1031 exchange treatment. In general, any type of real estate may be traded for another type of real estate as long as it satisfies the qualified use test.