Section 1031 Exchanges: Deferring Gain on Business or Investment Real Estate

Section 1031 can defer recognition of gain when qualifying real property held for productive use in a trade or business or for investment is exchanged for other qualifying real property. It is a deferral rule, not a permanent exclusion, and it generally no longer applies to equipment, vehicles, artwork, or other personal property.

Like-Kind Is Broad for Domestic Real Estate

Domestic real property generally can be exchanged for a different type of domestic real property: for example, vacant land for a rental building. Property held primarily for sale, such as dealer inventory, does not qualify. A primary residence, vacation home, partnership interest, foreign real estate, and mixed personal-use property require separate analysis.

The Deadlines Are Strict

In a deferred exchange, replacement property generally must be identified in a signed writing within 45 days after the transfer of the relinquished property. The replacement property generally must be received by the earlier of 180 days after that transfer or the due date of the return, including extensions, for the year of transfer. These periods generally are not extended because negotiations or financing take longer.

Do Not Receive the Sale Proceeds

A qualified intermediary is commonly used so the taxpayer does not have actual or constructive receipt of the proceeds. The exchange agreement and intermediary generally must be in place before closing. Moving the proceeds to the taxpayer's own account and trying to reinvest them later usually does not create a deferred exchange.

Cash, Debt Relief, and Other Property Can Trigger Gain

Receiving cash, nonqualifying property, or net debt relief can create recognized gain, often called boot, up to the realized gain. Reinvesting all cash does not by itself guarantee full deferral if liabilities change. Exchange expenses, closing costs, financing items, and property-tax prorations should be classified carefully.

Basis and Depreciation Carry Forward

The replacement property's basis generally reflects a carryover of the relinquished property's deferred gain, adjusted for additional consideration and recognized gain. Prior depreciation and new basis components can create multiple depreciation schedules. A later taxable sale may recognize the deferred gain and applicable depreciation recapture or unrecaptured Section 1250 gain.

Related-party exchanges, reverse exchanges, construction exchanges, entities changing ownership before or after closing, and exchanges involving residences or partnerships have additional restrictions. Form 8824 is generally filed for the exchange year. This article is general federal tax information; exchange planning should occur before the first closing.

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