Learn about how the year-end 1031 exchange works and what restrictions apply to exchangers.
- Under IRC §1031 individuals and businesses may exchange qualifying property for like-kind replacement property.
- Only property held for investment or for productive use in a trade or business qualifies for a like-kind exchange.
- Taxpayers need to be aware of all timing restrictions under Section 1031 of the Internal Revenue Code (IRC §1031).
Taxpayers who participate in a tax-deferred exchange under Section 1031 of the Internal Revenue Code (IRC §1031) are almost always advised about the timing restrictions involved in those transactions. However, not all taxpayers, also known as exchangers, fully understand the restrictions.
Exchangers have 45 days from the disposition of the relinquished property to identify potential replacement property to acquire. They also must complete their exchange before the earlier of 180 days from the disposition of the relinquished property or the due date of their tax return for the year in which the exchange was commenced. For example, if a calendar-year taxpayer disposed of relinquished property on December 1, 2019, their exchange period will expire on April 15, 2020. If he or she wishes to ensure the availability of the full 180 days to acquire replacement property, they must file for an extension using Form 8868. In the example above, if the exchanger files for an extension, he or she will have until May 29, 2020 to complete the exchange.
Like-kind exchanges can defer capital gains tax
Under IRC §1031 individuals and businesses may exchange qualifying property for like-kind replacement property. In qualifying transactions, the exchanger defers recognition of up to 100 percent of the capital gains and depreciation recapture that would otherwise occur at the sale of the property. This transaction structure is known as a “like-kind exchange.” Individuals and business who plan to sell real estate and then acquire new real estate shortly thereafter should discuss IRC §1031 with their tax and legal advisors and consider structuring the transaction as a like-kind exchange. The tax savings enable the reinvestment of more money into the replacement property.
How it works
In a typical like-kind exchange, the owner disposes of one or more relinquished properties and then later acquires replacement property. Prior to the disposition of the relinquished property, the owner and a qualified intermediary (QI) must enter an exchange agreement, and the owner’s rights in the contract of sale must be assigned to the QI. The sale proceeds are deposited with the QI, who holds them on behalf of the owner between the disposition and subsequent acquisition of replacement property. As noted above, the owner has 45 days to identify like-kind replacement property, and a total of 180 days (or the due date of the tax return, whichever is earlier) to acquire qualifying replacement property whose contract is also assigned to the QI. The owner then directs the QI to send proceeds to the seller and the sale is completed.
Qualified use property
Only property held for investment or for productive use in a trade or business qualifies for a like-kind exchange. Assets held primarily for personal use or by a dealer as inventory cannot be exchanged under §1031. Therefore, the owner must establish that any asset exchanged was held for investment rather than personal use.
Wilmington Trust can assist with your 1031 exchange
Wilmington Trust 1031 Exchange LLC is a nationwide provider of QI services. Our professionals have facilitated exchanges of all kinds, across the country and internationally. They will coordinate with your attorney and other professionals to ensure a smooth transaction at every step. We can help you complete both the disposition of your existing asset and the acquisition of your new one – from contract to closing.
IRC Section 1031 allows taxpayers to defer the gain on the disposition of business or investment real estate, if that real estate is replaced with like-kind real estate, within specific timeframes. Consult your tax or legal advisor for additional information on the requirements and limitations of such exchanges. Wilmington Trust 1031 Exchange LLC is a wholly owned subsidiary of Wilmington Trust, N.A. *Wilmington Trust 1031 Exchange LLC does not provide tax or legal advice to clients.