Considering a 1031 Tax-Deferred Exchange?

Considering a 1031 Tax-Deferred Exchange?

During this time of historic increases in property values, you may want to consider a 1031 tax-deferred exchange. This can be a great way to expand upon your investment portfolio. But how is this accomplished, and what are the requirements and restrictions that affect this process?

Disclaimer: I’m neither a tax accountant nor an attorney. But from my experience in being involved with such exchanges, there are a few things that you should know.

Generally speaking, the tax-deferred exchange was designed to allow a seller to defer the taxes on a gain from the sale of a qualifying property by allowing for the reinvestment (purchase) into another property, thereby delaying the payment of any taxes owed from the sale to a point in the future when that seller may be in a lower tax bracket.

However, you need to make sure that the properties involved in this sale and purchase meet the requirements (think IRS) for the exchange.

The three conditions for consideration are “qualifying property”, “time” and “intent”.

Properties that may qualify

Properties that qualify for the exchange are those that are considered to be “like-kind”, or residential property held for investment (non-personal primary use) for another residential property held for investment purposes, or commercial for commercial, for example. The definition seems to be fairly broad, so a rental condominium held for investment could be exchanged for residential land held for the same purpose. Do any tax advisors out there want to weigh in on this?

The “Time Factor”

The IRS, as well as the majority of advisors who I have dealt with, consider two years as the minimal amount of time that you must have held a property before you can sell it utilizing the 1031 exchange provisions. However, exchanges for properties held for less time have ultimately been approved. But some of these were requiring litigation to force the issue. The actual minimum amount of time doesn’t appear to be written into the tax code, but the IRS has issued rulings regarding the two-year period, while Congress has suggested a lesser period of just one year. Since you have to deal directly with the IRS, I would guess that the best advice is to consider two years as the minimum “safe” holding time, but you’ll want to check with your tax advisor on this.

This applies to the property being acquired as well. If the acquired property is then sold too quickly, the IRS may not allow the transaction to be treated under the Section 1031 rules.

What is the intent?

Real estate must be viewed as being held as an investment. Whether that means there is short-term rental income being produced by the property, or the property is being held primarily for its anticipated appreciation in value. In either case, the property can’t be viewed as serving a personal use role. This doesn’t mean that you can’t personally use the property occasionally, as in the case of a condo that you normally rent out but use once in a while. Personal use just can’t be the primary function of the property.

There are many more considerations involved in a 1031 Tax-Deferred Exchange, such as:

  1. When does the replacement property / properties have to be identified?
  2. How many properties can you identify as a possible replacement for the Exchange?
  3. What is the timeline for closing on the replacement property?
  4. Can I just handle the sale & purchase myself, or do I need to have someone assist me?
  5. Can I receive any funds from the closing, or do I need to put it all into the replacement property?
  6. There are also tax issues to be considered before pursuing this process.

For more information, you should seek the advice of your attorney, CPA, tax advisor, etc.
You can also contact me directly and I can recommend the services of several local service providers.

Information for this commentary was sourced from:

How Can I Help?

I hope that you’ve found this information on the 1031 tax-deferred exchange informative. My goal is to provide my clients with relevant and up-to-date information that pertains to the local area and real estate topics. 

If you want more information on what the Breckenridge-Frisco area Real Estate Market is like right now don’t hesitate to reach out. I can provide you with a detailed market report! 

Scott Lerner
Managing Broker
Coldwell Banker Mountain Properties