How Can I Make Sure I Receive Like-Kind Exchange Treatment Under Section 1031?

Section 1031 of the Internal Revenue Code (IRC) allows taxpayers to indefinitely defer federal income tax liability resulting from qualifying real estate transactions. To claim tax deferral under Section 1031, taxpayers must simply report the relevant transaction (or transactions) using IRS Form 8824. An experienced 1031 exchange facilitator can help, and, in many cases, working with a 1031 exchange facilitator will be a necessary part of the process (more on this below).

Claiming indefinite tax deferral—and especially substantial indefinite tax deferral—can trigger scrutiny from the IRS. If the IRS determines that a taxpayer has improperly claimed like-kind exchange treatment under Section 1031, the IRS can impose immediate tax liability (plus interest and penalties). With this in mind, it is critical that taxpayers ensure that their transactions qualify before filing IRS Form 8824.

 5 Key Steps to Qualify for Like-Kind Exchange Treatment Under Section 1031

So, what can (and should) taxpayers do to ensure that they receive like-kind exchange treatment under Section 1031? Here are five key steps in the process:

1. Ensure the Relinquished Property and Replacement Property Are of “Like Kind”

One of the main requirements under Section 1031 is that the properties involved in the transaction (referred to as the relinquished property and replacement property) must be of “like kind.” Under the IRS’s current rules, this is typically fairly straightforward. As the IRS explains:

“Properties are of like-kind if they’re of the same nature or character, even if they differ in grade or quality. [P]roperties [also] generally are of like-kind[] regardless of whether they’re improved or unimproved.”

However, there are exceptions. For example, properties in the United States are not considered to be of like kind with properties in foreign countries under any circumstances. As a result, ensuring that the relinquished property and replacement property are of like kind is a key first step.

2. Ensure Both Properties Are “Held for Productive Use in a Trade or Business or for Investment”

To qualify under Section 1031, a transaction must involve properties that are both “held for productive use in a trade or business or for investment.” Additionally, the properties involved must not be “held primarily for sale.”

This means that transactions involving primary residences, second homes, vacation homes, and “flip” properties generally do not qualify for like-kind exchange treatment under Section 1031. However, all of these types of property can be transformed into qualifying properties by taking steps to prepare in advance of a planned exchange.

3. Make Sure You Can Meet the Strict Deadlines that Apply

Under Section 1031, all like-kind exchanges are subject to strict deadlines. The two major deadlines under Section 1031 are:

• Identification of the Replacement Property – Taxpayers must identify their replacement property within 45 days of selling their relinquished property.
• Taking Possession of the Replacement Property – Taxpayers must take possession of their replacement property within 180 days of selling their relinquished property.

Missing either of these deadlines, even by a day, can prevent taxpayers from claiming indefinite tax deferral. This makes it imperative for taxpayers seeking to take advantage of Section 1031 to ensure that they can meet both of these deadlines—and that they can prove they have met these deadlines to the IRS if necessary.

4. Ensure that You Correctly Identify and Characterize Any “Boot” from the Transaction

If a transaction involves the acquisition of a replacement property plus additional property that does not qualify as “like kind” under Section 1031, this additional property is classified as “boot.” In this scenario, the boot acquired in the transaction is subject to immediate federal taxation. Here too, improperly claiming tax deferral can lead to interest and penalties—and it can lead to further scrutiny from the IRS as well.

5. Work with a 1031 Exchange Facilitator Throughout the Process

To ensure compliance with all applicable requirements, taxpayers can work with an experienced 1031 exchange facilitator throughout the process. An experienced 1031 exchange facilitator will be able to assist with everything from meeting the identification and timing requirements to documenting taxpayers’ compliance with the Internal Revenue Code. Exchange facilitators can manage the transfer of funds during reverse exchanges and delayed exchanges as well, which can be another critical step for securing indefinite tax deferral.  

Schedule a Call with a 1031 Exchange Facilitator at 1031 National Services

If you would like to know more about how you can make sure you receive like-kind exchange treatment under Section 1031, we invite you to get in touch. To schedule a call with an experienced 1031 exchange facilitator at 1031 National Services, please call 888-872-1031 or request a free consultation online today.