Preserve Section 1031 exchanges

The IRS has recently announced that it will be scrutinizing “Section 1031 exchanges” of real estate to ensure that such exchanges comply with all the tax law requirements in this area. Nevertheless, you can still avoid current tax by following the rules to the letter.

Under Section 1031 of the tax code, you may defer taxable gains when exchanging properties that are similar in nature, except to the extent that you receive cash or other “boot” as part of the transaction. In that case, you must pay current tax on the gain up to the amount of boot received. Otherwise, you owe no tax until you sell the newly acquired property.

This is one of the rare instances when the tax law lets you off the hook for a disposition of appreciated property.

To qualify as a like-kind exchange, both the property being relinquished and the property being acquired must be investment or business property. You can’t swap personal property tax-free under Section 1031.

“Like-kind” refers to the property’s nature or character. Tax regulations provide a liberal interpretation of this standard. Examples: You can swap improved real estate for raw land, a shopping mall strip for an apartment building, a marina for a golf course. But you can’t swap real estate for personal-property assets such as equipment or vehicles.

The tax law also imposes timing restrictions on Section 1031 exchanges. You must identify (or actually receive) the replacement property within 45 days of transferring legal ownership of the relinquished property. Also, the title to the replacement property must be transferred within the earlier of 180 days or your tax return due date, plus extensions, for the tax year of the transfer.

Obviously, this is a complex area of the tax law. If you are considering a like-kind exchange of real estate, we can help address your personal situation. Call 562-868-6333 to arrange a meeting with an experienced tax professional.

P.S. The IRS has put investors on notice that it will be investigating Section 1031 exchanges that do not observe all the technical formalities.