• Like-kind exchange law was enacted with the Revenue Act of 1921, allowing property to be sold and a replacement property purchased without taxing gains on the initial property. The 1921 act included both like-kind and non-like-kind property exchanges, and its aims were to avoid unfair taxation of ongoing investments and to encourage active reinvestment.
• Investors can take advantage of a 1031 tax-deferred exchange to exchange property that’s residential, commercial, industrial, or leased if the lease is for 30 years or more and includes ownership interest.
• Anyone considering a 1031 exchange should meet with a qualified tax professional for advice.
• An investor can use one type of investment or business property to exchange for another type. For example, an apartment house may be used in an exchange with a duplex, warehouse, or office building.
• A like-kind exchange, or 1031 exchange, is also referred to as a tax-deferred exchange.
• Boot is money or property received in excess in a 1031 exchange. Types of boot include cash (equity) boot, mortgage boot, and personal property received as consideration.
• The three-property rule relating to tax-deferred exchanges means that up to three properties may be identified for any price as long as the investor closes on one of them as the replacement property. This is by far the most commonly used identification rule for tax-deferred exchanges due to no fair market value restrictions.
• Mortgage boot applies when the taxpayer owes less debt on the replacement property than what was owed on the relinquished property. Taxes must be paid on this difference.
• The relinquished property is the one given up in a tax-deferred exchange, and the replacement property is the one for which the relinquished property is exchanged.
• The 200% rule relating to tax-deferred exchanges means any number of properties may be identified as long as the fair market value of the identified replacement properties doesn’t exceed 200% of the relinquished property’s selling price. Using list price is likely okay to determine fair market value.
• The 95% rule relating to tax-deferred exchanges means that the taxpayer is allowed to identify more than three properties with a total value that exceeds 200% of the value of the relinquished property, but only if the investor acquires at least 95% of the properties identified. It’s rarely used because, to make this rule work in practice, the investor would need to acquire everything that was identified.
• An improvement exchange permits the exchanger, using a qualified intermediary and exchange accommodation titleholder, to make improvements to a replacement property using exchange equity.
• A qualified intermediary is the entity, not related to the exchanger, who facilitates the exchange, receives a fee, receives the relinquished property from the exchanger and sells it to the buyer, and purchases the replacement property from the seller and transfers it to the exchanger.
• The total exchange period is 180 calendar days from the relinquished property’s transfer or the day the tax return is due (whichever is sooner) from the relinquished property’s settlement.
• An exchanger is the entity doing the tax-deferred, like-kind exchange transaction (e.g., the investor who’s selling a property and purchasing another using a 1031 exchange).
• The 1031 tax-deferred exchange is used to defer paying taxes when there’s an almost immediate repurchase of like-kind property, which is one used for investment or business purposes.
• The exchange period is the time frame in which the replacement property must be acquired (180 days).
• The identification period is the time frame in which the investor must locate and identify (in writing, or by actual receipt of the property during this time) a potential replacement property (within 45 days of the relinquished property’s transfer).
• With the like-kind exchange law, found in 26 U.S. Code § 1031, no current-year gain or loss will be recognized on the exchange of real property held for productive use in a business or for investment if exchanged solely for like-kind property to be held for business or investment.
• The 1031 exchange law doesn't permit stock in trade, stocks, bonds, or notes, securities, interests in partnership, or certificates of trust or beneficial interests.
• When an investor purchases a property for a 1031 exchange, the investor's intent is a critical issue: The investor must intend to hold the property for the purpose of renting, investing, or using in a trade or business. If the property was a primary residence only, it would be disqualified from being used in a 1031 exchange. The holding period isn’t specified, which may create an issue in qualifying for the exchange.
• A § 1031 tax-deferred exchanges is limited to property within the U.S., so a foreign property may not be exchanged for a U.S. property because they’re not considered like-kind per the exchange law.
• If an exchange is not deemed a like-kind exchange, it could have adverse tax effects for the taxpayer because any gain could be considered ordinary income and therefore not subject to 1031 rules.
• If a vacation home/second home property qualifies under an IRS safe harbor rule, the IRS won’t challenge whether it qualifies for a tax-deferred exchange. A taxpayer may have a rental and occasionally use it for personal enjoyment and still meet safe harbor guidelines.
• For a second home or vacation home to qualify for a 1031 exchange under IRS safe harbor rules, it must be owned for at least 24 months prior to the exchange, rented out at a fair rental rate for 14 days or more each of those two years, and occupied for personal use for 14 or fewer days each year, or no more than 10% of the number of days rented during a 12-month period.
• If a client needs to exchange a vacation property or second home, legal and tax advisors should be consulted. Even if it’s outside the safe harbor guidelines, a 1031 exchange may still be possible.
• Title 26 of the U.S. Code § 121 involves personal residences, specifically exclusion of gain from the sale or exchange of a principal residence. Section 121 can be combined with § 1031 for property that has changed use from an investment property to a primary residence under certain circumstances. The look-back period is five years, for which the property must have been used as a primary residence for two years or more.

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