In order to complete a Section 1031 Exchange, both the sold ('Relinquished') property and the acquired ('Replacement') property must qualify as ‘like-kind’ pursuant to the guidelines set forth in the IRS Regulations.  The like-kind rules for real estate exchanges and personal property exchanges are set forth below. 


Like-kind Requirements for Real Estate Exchanges

The like-kind requirement for real property exchanges is fairly easily satisfied.  To qualify for a Section 1031 Exchange, all properties in the exchange must initially meet these standards:

1.  Properties must be defined as real property under applicable state law.  Many taxpayers associate Section 1031 Exchanges with fee interests, however many other real property interests also may qualify.  These includes tenant in common interests in qualifying real property, also conservation easements, perpetual water rights, and co-op interests.  The like-kind test for these non-fee interests is that they must be considered a real property interest by the law of the state in which the property or interest is located. 

 

2.  Properties must be ‘used in a trade or business, or held for investment.’  As a general rule, this includes most properties that are rented or leased to a tenant at a fair market value rental.  This definition excludes property with significant personal use, and property that is ‘held for sale’ or ‘acquired for resale,’ often referred to as ‘inventory’ or ‘dealer property.’   

 

In February, 2008, the IRS released Revenue Procedure 2008-16, which is effective for exchanges occurring on or after March 10, 2008.  Rev. Proc. 2008-16 establishes a ‘safe harbor’ under which the IRS will not challenge whether or not a dwelling unit meets the qualifying use requirement.  To meet the safe harbor guidelines, the ‘Relinquished’ property must meet the following requirements:

 

a. The property must be owned by the taxpayer for at least 24 months immediately prior to the exchange; and

 

b. In each of the two 12-month periods prior to the beginning of the exchange, the taxpayer must have rented the property to another person for 14 days or more at a rental equal to its fair market value; and

 

c.  In each of the two 12-month periods prior to the exchange, the taxpayer’s personal use of the property must not exceed the greater of (i) 14 days; or (ii) ten percent of the number of days the property is rented at its fair market value.

 

The ‘Replacement’ property in the exchange must meet similar requirements in order to meet the safe harbor requirements of Rev. Proc. 2008-16:

 

a. The property must be owned by the taxpayer for at least 24 months immediately following the exchange; and

 

b. In each of the two 12-month periods immediately after the exchange, the taxpayer must rent the property to another person at its fair market value; and

 

c.  In each of the two 12-month periods immediately after the exchange, the taxpayer’s personal use of the property must not exceed the greater of (i) 14 days; or (ii) ten percent of the number of days the property is rented at its fair market value.

 

Please remember, Rev. Proc. 2008-16 establishes a safe harbor for properties in a 1031 exchange to meet the ‘qualifying use’ guidelines.  Failure to meet the safe harbor requirements does not necessarily disqualify a property for a Section 1031 exchange.  It is advisable for property owners interested in an exchange to review their facts and circumstances with a tax advisor, if their ownership and use of a property does not meet the safe harbor guidelines. 

 

 3.  Properties located within the 50 States, the District of Columbia, and the US Virgin Islands are considered like-kind with other properties so located.  Properties located outside of these regions are considered like-kind with other properties that also are located outside of these regions.
 

Please note the flexibility provided by Section 1031 to owners of real property.  The like-kind requirements allows you to exchange, for example, land for a multi-family rental unit, an apartment building for an office building, a retail property for an industrial property, undeveloped land for a rental property in a resort area.   

You are welcome to contact the professionals of Beacon Exchange Company if you would like more information regarding the like-kind requirement for real property exchanges.