Since 1921, U.S. tax law has recognized that the exchange of one investment or business-use property for another of like-kind results in no change in the economic position of the taxpayer, and therefore, should not result in the immediate imposition of income tax.
The exchange rules permit the deferral of taxes, so long as the taxpayer satisfies numerous requirements and consummates both a sale and purchase within 180 days.
National Association of Realtors’ Director of Tax Policy, Evan Liddiard, recently gave guidance on Section 1031 of the Internal Revenue Code and explained that the code underwent a major change in 2017 with the Tax Cuts and Job Act.
This change removed both personal use property and personal property and collectibles, leaving only real property.
This change excluding personal use property affects vacation homes qualifying for 1031 exchanges.
Fortunately, the favorable treatment of all types of real estate being considered like-kind to all other real estate still applies.
For example, a farm and an apartment building are considered to be like-kind, as are a movie theater and an office building. The property does have to be within the United States however to be considered like-kind.
Section 1031 allows for two kinds of exchanges with the help of an intermediary – simultaneous exchanges and deferred exchanges.
Simultaneous exchange is where the investor has already identified the new property purchase and the sales contract and purchase contract happen simultaneously.
In a deferred exchange, the old property is sold on “Date 1,” but they have not identified the replacement property by “Date 1.”
The intermediary holds the money from the date of the sale of the old property until the new property is identified and purchased.
The date requirements dictate that the taxpayer has 45 days from the date of the sale of the old property to identify the possible new property and send notice to the intermediary within 45 days (up to three properties can be identified).
Then, the taxpayer must close on the replacement property within 180 days of the transfer of the old property, known as the 180-day rule.
Lauren Bunting is a Broker with Keller Williams Realty of Delmarva in Ocean City, Maryland.
