1031 Exchange FAQ
Note: The information provided herein has been collected from the IRS Website and is not guaranteed or endorsed by Bob and Linda Lario. For more information, please contact www.irs.gov or a 1031 exchange qualified intermediary.
1. Are 1031 tax deferred exchanges the same thing as a 1031 tax exchange?
Most likely, yes. If someone says, 1031 exchange, 1031 tax deferred exchange, or tax free real estate exchange, in all likelihood they are all talking about the same thing. Section 1031 of the Internal Revenue Service code provides for a “tax deferred exchange” of like kind real estate. This means that for the same “type” of real estate, you can “exchange” it into a similar piece or pieces of property and not pay any capital gains tax when you sell.
The 1031 tax free exchange is really called a Like Kind or tax deferred exchange. A Like Kind exchange refers to the ability of a property owner to sell one property (or group of properties) and “replace” them with a more expensive or less expensive one (or group of properties). There are certain conditions that must be met in order to satisfy the IRS and allow for the completion of the exchange. Section 1031 of the IRS tax code spells out the specifics of what steps an individual or other entity must take to satisfy their requirements. Basically, a property owner is allowed to take all of the proceeds from the sale of income producing property and “trade” them into another property without paying taxes on any capital gains they may have made. Provided the procedures are followed and no money is taken out of the exchange, no taxes will be due on the capital gains that year.
2. Can you sell rental property and reinvest it into rental property without paying capital gains tax?
No. A deferred exchange will be treated as a sale rather than a tax free exchange if the taxpayer actually or constructively receives money on other property in full consideration of the relinquished property. However, rental property may be exchanged directly for other rental property of like kind. Gain realized from such an exchange is deferred. For additional information on like-kind exchanges, refer to Publication 544, Sales and Other Dispositions of Assets.
3. I have heard that I can sell my rental property and use the proceeds to purchase rental property of equal or greater value and the transaction is viewed just like an exchange in that the tax is deferred until the new property is sold. Is this true?
What you have heard about is a like-kind exchange. A like-kind exchange, when properly executed, represents a way to postpone the recognition (taxation) of gain essentially by shifting the basis of old property to new property. If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized gain or loss. The basis of the property received is the basis of the property given up, increased by the money paid. There are several rules and restrictions that must be strictly adhered to in order for a successful exchange to take place. Deferred exchanges will be treated as a sale rather than an exchange to the extent that the taxpayer actually or constructively receives money or other (not like kind) property in exchange for the like-kind property given up. For more information refer to Publication 544 (Sales and Other Disposition of Assets), and Form 8824 (PDF – Instructions, Like-Kind Exchanges).
4. Can we move into our rental property, live there as our main home for two years, and sell it without having to pay capital gains tax?
You may be able to exclude your gain from the sale of your main home that you have also used for business or to produce rental income if you meet the ownership and use tests, detailed in Publication 523, Sale of Your Home.
However, if you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997. (Note: If you can show by adequate records or other evidence that the depreciation deduction allowed (did deduct) was less than the amount allowable (could have deducted), the amount you cannot exclude is the smaller of those two figures.)
The gain, exclusion, and depreciation recapture should be reported on Form 1040, Schedule D, Capital Gains and Losses, as described in Publication 523, Selling Your Home.
5. Additional References and Resources
Publication 523, Selling Your Home Form 1040, Schedule D (PDF), Capital Gains and Losses
Publication 544, Sales and Other Dispositions of Assets
Form 8824, Like-Kind Exchanges (PDF)
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