By Eddie Rivera, CPA, MST, Sax LLP
A 1031 exchange (like-kind exchange) is one of the most significant tax advantages available to a real estate investor selling a property with large realized gains. By implementing this tax strategy, it is possible to defer tax payments on the sale of an investment property indefinitely.
While like-kind exchanges are common, there are still many complexities to navigate. Given some of the proposed legislative changes put forth by the Biden administration and members of Congress, it may make sense to accelerate transactions into the 2021 tax year. It is vital that you have experienced and knowledgeable advisors in your corner to guide you through the process.
The intention of this article is to dive into where we’ve been with the 1031 like-kind exchange benefit and provide information to help you take advantage of the benefit today.
The history of the 1031 exchange transaction can be traced back to The Revenue Act of 1921 with the basic idea that if an investor does not receive any cash proceeds (referred to as boot) from a sale of property, then there isn’t any income to tax. Throughout the ensuing decades, there have been various changes to the code and regulations.
One of the more important events to shape the law was a court case commonly known as the “Starker Family Case” where the taxpayer exchanged land with a corporation in exchange for a promise to receive like-kind property in five years (or cash if not like-kind property). The IRS considered this a taxable sale; however, the taxpayer won the case and made the now commonly used forward exchange famous — selling relinquished property and obtaining the replacement property within specified time limits.
Our current statute restricts the replacement property identification period of a forward exchange to 45 days from closing of the relinquished property. Also, replacement property must be acquired within 180 days from closing of the relinquished property.
Evolution of the Law
Since the Starker Family Case, subsequent laws, regulations and IRS guidance followed which includes:
- Revenue Ruling 99-6 (While not directly related to 1031, the ruling details deemed asset sales on the conversion of a multi-member LLC to a single member LLC. This is a useful tool for 1031 planning around partnership structures.)
- Revenue Procedure 2000-37 (Reverse 1031 Exchanges – where you obtain title to the replacement property first and then sell the relinquished property.)
- Revenue Procedure 2002-22 (regarding rules for TIC Exchanges)
- Revenue Ruling 2004-86 (regarding rules for DST Exchanges)
- Tax Cuts and Jobs Act of 2017 (Made personal property ineligible for like-kind exchanges.)
What to Know About the Law Today
Many real estate investors do not fully understand what qualifies today for 1031 exchange treatment. Here is a list of further defined real property that includes intangible assets that are eligible:
- Fee ownership
- A leasehold interest
- An option to acquire real property
- An easement
- Stock in a cooperative housing corporation
- A license, permit, or other similar right that is solely for the use, enjoyment or occupation of land
If you are contemplating selling real estate, it is important that you have a knowledgeable advisor in your corner that can help you navigate the nuances. You should be actively speaking with your trusted advisor as there are benefits to surely take advantage of and there may be changes on the horizon.
About the Author
EDDIE RIVERA, CPA, MST is a Partner at Sax LLP and a member of the firm’s Real Estate Practice. He has a diverse technical background delivering tax, accounting and auditing services to some of the largest privately owned real estate and construction enterprises in the Tri-state area. He can be reached at firstname.lastname@example.org.