Although many types of assets qualify for a Section 1031 Exchange, real property is the most common asset involved in 1031 exchanges.  Real estate historically has appreciated over time, sometimes achieving dramatic increases in value over relatively short intervals.  This appreciation, coupled with depreciation recapture that is realized when improved real estate is sold, can result in a significant capital gains tax liability.  This liability can be deferred, and equity is thus preserved, with a successful Section 1031 Exchange strategy.

Another reason why real property is common in 1031 Exchanges is the broad range of replacement properties that satisfy the like-kind requirement.  For example, land, any character of residential rental property, as well office, retail, and industrial properties, all may be considered to be ‘like-kind’ pursuant to treasury regulations.  In addition, non-fee interests such as easements, air and water rights, and co-op interests may qualify, depending on applicable state law.  Please see our webpage titled the ‘Like-Kind Requirement’ for additional information on the like-kind rules. 

Some of the reasons why an investor may desire to sell a ‘business or investment’ property include:

1.  Change the character of the property; sell raw land for an income producing property; or sell a residential rental property that requires significant time and management effort for a commercial property subject to a single tenant, multi-year lease.   

2.    Change location: A property owner may see greater potential for appreciation in another area of the state, or in another region of the country. If the property owner relocates, he or she may desire to sell a currently owned property and acquire another investment property near his or her new residence. 

3.    Acquire a larger property: The strategy of many real estate investors is to build wealth by trading up to larger properties. 

4.    Diversify or Consolidate:  A property owner can sell two properties and take back one, or sell one and take back three to complete a Section 1031 exchange. 

Investors with any of these circumstances may have the opportunity to preserve equity, thereby lowering their borrowing requirements and monthly interest expense, by carefully considering a Section 1031 Exchange when selling and acquiring investment real property.  
 

Principal Residences and Second Homes.

Please remember principal residence does not meet the ‘trade or business use’ requirement, and therefore do not qualify for a Section 1031 Exchange.  Principal residences may, however, qualify for the  $250,000 / $500,000 Section 121 exclusion, provided certain rules are satisfied.  Please visit our Section 1031 Library for more information relating to selling a principal residence.

Second or Vacation homes may meet the ‘trade or business use’ requirement, and therefore would qualify for a Section 1031 Exchange.  Second homes with significant personal use, however, may be considered a ‘residence’ rather than a ‘business or investment, disqualifying them from a Section 1031 exchange.  Please see our webpage titled Second Homes for more information on this subject. 


Summary

If you are selling a rental condominium or a resort property; a small retail property to a large shopping center, an apartment or an office building; if you are an accountant, attorney, financial planner, or advisor who is assisting a client to evaluate the sale and purchase of investment real estate, we invite you to contact Beacon Exchange Company and review your 1931 exchange options with us.  Exchanges provide significant tax advantages, and can be tailored to your circumstances in most cases.