1031 Exchange Information

Overview of 1031 Exchanges

A 1031 exchange (also called a like-kind exchange or a Starker) is a swap of one business or investment asset for another. If you meet the criteria for a 1031 exchange, you’ll either have no tax or limited tax due at the time of the exchange.

Note:  IRC § 1031(a)  Provides that no gain or loss is recognized when property held for productive use in a trade or business, or for investment, is exchanged solely for property of a “like kind” that is also to be held either for the productive use in a trade or business or for investment.

               

Key Facts of 1031 Exchanges:

Warning: Special rules apply when depreciable property is exchanged in a 1031. It can trigger gain known as “depreciation recapture” that is taxed as ordinary income. In general, if you swap one building for another building, or one machine for another machine, or one fishing boat for another, you can avoid this recapture. However, if you exchange improved land with a building for unimproved land without a building, the depreciation you’ve previously claimed on the building will be recaptured as ordinary income.

Such complications are why you need professional help when you’re doing a 1031.

In 2004 Congress tightened that loophole. Yes, taxpayers can still turn vacation homes into rental properties and do 1031 exchanges. Example: You stop using your beach house, rent it out for six months or a year and then exchange it for other real estate. If you actually get a tenant and conduct yourself in a businesslike way, you’ve probably converted the house to investment property, which should make your 1031 exchange OK. But if you merely hold it out for rent but never actually have tenants, it’s probably not. The facts will be key, as will the timing. The more time that elapses after you convert the property’s use the better. Although there is no absolute standard, anything less than six months of bona fide rental use is probably not enough. A year would be better.

If you want to use the property you swapped for as your new second or even primary home, you can’t move in right away. In 2008 the IRS set forth a safe harbor rule under which it said it would not challenge whether a replacement dwelling qualified as investment property for purposes of a 1031. To meet that safe harbor, in each of the two 12-month periods immediately after the exchange: (1) you must rent the dwelling unit to another person for a fair rental for 14 days or more; and (2) your own personal use of the dwelling unit cannot exceed the greater of 14 days or 10% of the number of days during the 12-month period that the dwelling unit is rented at a fair rental.

Moreover, after successfully swapping one vacation/investment property for another, you can’t immediately convert it to your primary home and take advantage of the $500,000 exclusion. Before the law was changed in 2004 an investor might transfer one rental property in a 1031 exchange for another rental property, rent out the new rental property for a period of time, move into the property for a few years and then sell it, taking advantage of exclusion of gain from the sale of a principal residence. Now, if you acquire property in the 1031 exchange and later attempt to sell that property as your principal residence, the exclusion will not apply during the five-year period beginning with the date the property was acquired in the 1031 like-kind exchange. In other words, you’ll have to wait a lot longer to use the primary residence capital gains tax break.

Credits:

Robert W. Wood is a tax lawyer with a nationwide practice. The author of more than 30 books including Taxation of Damage Awards & Settlement Payments (4th Ed., 2009), he can be reached at wood@woodporter.com. This discussion is not intended as legal advice and cannot be relied upon for any purpose without the services of a qualified professional.

https://www.1031exchangemadesimple.com/

http://www.forbes.com/2010/01/26/capital-gains-tax-1031-vacation-home-personal-finance-robert-wood.html

http://www.irs.gov/publications/p544/ix01.html

 

FISHERY EXAMPLE: Like-kind Exchanges

 

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Fishing-Audit-Technique-Guide#ch5-Exchanges2

A like-kind exchange is the exchange of business property for similar business property rather than cash.  It is the most common type of nontaxable exchange.

The exchange of a fishing permit/license for another fishing permit/license qualifies for nontaxable exchange treatment under IRC § 1031, regardless of whether the permit is for a different fishery, a different species of fish, or a different type of fishing gear.

Any time a fisher sells his permits/licenses for more than the current adjusted basis (purchase price minus claimed amortization), he incurs a tax liability.  For example, if Captain Fisher buys a fishing permit for $100,000 in April 2002 and sells it in May 2010 for $150,000, he must pay taxes on the $50,000 capital gain. In addition, because he has amortized the permit/license (taken a deduction on his returns), he would also be liable for taxes on the amortized amount claimed of $53,336 (8 years @ $6,667). This amount would be reported as an ordinary gain.

If the fisher does a like-kind exchange under IRC § 1031 he can defer the capital and ordinary gains.  This code section allows owners to defer the gain on the disposal of business property if, rather than selling for cash, they trade it for another item of business property of a similar type, i.e., a fishing permit for a fishing permit.  The tax liability is not eliminated, but rather is deferred until the sale of the newly acquired fishing permit/license.

Example:  If Captain Fisher’s original $100,000 fishing permit has a current value of $150,000 and he trades it for another, the $50,000 capital gain and $53,336 ordinary gain can be deferred until he sells the new fishing permit. Basis in the new permit is adjusted by the gain deferred.

This example would also apply to a fishing vessel.

To qualify for treatment as a nontaxable exchange under IRC § 1031:

If a fisher receives money or unlike property as part of the trade, or his permit or boat had a note that the other party assumed, he might have to report a gain to the extent of the money or unlike property received.

Exchanges of like-kind properties are reported on Form 8824.  For more information about exchanges, see IRS Publication 544 and IRC § 1031.

Overview of 1031 Exchanges

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A 1031 exchange (also called a like-kind exchange or a Starker) is a swap of one business or investment asset for another. If you meet the criteria for a 1031 exchange, you’ll either have no tax or limited tax due at the time of the exchange.

Note:  IRC § 1031(a)  Provides that no gain or loss is recognized when property held for productive use in a trade or business, or for investment, is exchanged solely for property of a “like kind” that is also to be held either for the productive use in a trade or business or for investment.

               

Key Facts of 1031 Exchanges:

Warning: Special rules apply when depreciable property is exchanged in a 1031. It can trigger gain known as “depreciation recapture” that is taxed as ordinary income. In general, if you swap one building for another building, or one machine for another machine, or one fishing boat for another, you can avoid this recapture. However, if you exchange improved land with a building for unimproved land without a building, the depreciation you’ve previously claimed on the building will be recaptured as ordinary income.

Such complications are why you need professional help when you’re doing a 1031.

In 2004 Congress tightened that loophole. Yes, taxpayers can still turn vacation homes into rental properties and do 1031 exchanges. Example: You stop using your beach house, rent it out for six months or a year and then exchange it for other real estate. If you actually get a tenant and conduct yourself in a businesslike way, you’ve probably converted the house to investment property, which should make your 1031 exchange OK. But if you merely hold it out for rent but never actually have tenants, it’s probably not. The facts will be key, as will the timing. The more time that elapses after you convert the property’s use the better. Although there is no absolute standard, anything less than six months of bona fide rental use is probably not enough. A year would be better.

If you want to use the property you swapped for as your new second or even primary home, you can’t move in right away. In 2008 the IRS set forth a safe harbor rule under which it said it would not challenge whether a replacement dwelling qualified as investment property for purposes of a 1031. To meet that safe harbor, in each of the two 12-month periods immediately after the exchange: (1) you must rent the dwelling unit to another person for a fair rental for 14 days or more; and (2) your own personal use of the dwelling unit cannot exceed the greater of 14 days or 10% of the number of days during the 12-month period that the dwelling unit is rented at a fair rental.

Moreover, after successfully swapping one vacation/investment property for another, you can’t immediately convert it to your primary home and take advantage of the $500,000 exclusion. Before the law was changed in 2004 an investor might transfer one rental property in a 1031 exchange for another rental property, rent out the new rental property for a period of time, move into the property for a few years and then sell it, taking advantage of exclusion of gain from the sale of a principal residence. Now, if you acquire property in the 1031 exchange and later attempt to sell that property as your principal residence, the exclusion will not apply during the five-year period beginning with the date the property was acquired in the 1031 like-kind exchange. In other words, you’ll have to wait a lot longer to use the primary residence capital gains tax break.

Credits:

Robert W. Wood is a tax lawyer with a nationwide practice. The author of more than 30 books including Taxation of Damage Awards & Settlement Payments (4th Ed., 2009), he can be reached at wood@woodporter.com. This discussion is not intended as legal advice and cannot be relied upon for any purpose without the services of a qualified professional.

https://www.1031exchangemadesimple.com/

http://www.forbes.com/2010/01/26/capital-gains-tax-1031-vacation-home-personal-finance-robert-wood.html

http://www.irs.gov/publications/p544/ix01.html

 

FISHERY EXAMPLE: Like-kind Exchanges

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Fishing-Audit-Technique-Guide#ch5-Exchanges2

A like-kind exchange is the exchange of business property for similar business property rather than cash.  It is the most common type of nontaxable exchange.

The exchange of a fishing permit/license for another fishing permit/license qualifies for nontaxable exchange treatment under IRC § 1031, regardless of whether the permit is for a different fishery, a different species of fish, or a different type of fishing gear.

Any time a fisher sells his permits/licenses for more than the current adjusted basis (purchase price minus claimed amortization), he incurs a tax liability.  For example, if Captain Fisher buys a fishing permit for $100,000 in April 2002 and sells it in May 2010 for $150,000, he must pay taxes on the $50,000 capital gain. In addition, because he has amortized the permit/license (taken a deduction on his returns), he would also be liable for taxes on the amortized amount claimed of $53,336 (8 years @ $6,667). This amount would be reported as an ordinary gain.

If the fisher does a like-kind exchange under IRC § 1031 he can defer the capital and ordinary gains.  This code section allows owners to defer the gain on the disposal of business property if, rather than selling for cash, they trade it for another item of business property of a similar type, i.e., a fishing permit for a fishing permit.  The tax liability is not eliminated, but rather is deferred until the sale of the newly acquired fishing permit/license.

Example:  If Captain Fisher’s original $100,000 fishing permit has a current value of $150,000 and he trades it for another, the $50,000 capital gain and $53,336 ordinary gain can be deferred until he sells the new fishing permit. Basis in the new permit is adjusted by the gain deferred.

This example would also apply to a fishing vessel.

To qualify for treatment as a nontaxable exchange under IRC § 1031:

If a fisher receives money or unlike property as part of the trade, or his permit or boat had a note that the other party assumed, he might have to report a gain to the extent of the money or unlike property received.

Exchanges of like-kind properties are reported on Form 8824.  For more information about exchanges, see IRS Publication 544 and IRC § 1031.