Types of Exchanges That Don’t Qualify Under 1031 Rules

which of the following would not qualify as a 1031 exchange?

Before the Tax Cuts and Jobs Act in December 2017, things like franchise licenses and aircraft could be swapped in a 1031 exchange. But now, they no longer qualify, making the rule apply only to real property. It’s key for those in real estate and tax-deferred exchanges to know what doesn’t qualify.

Under 1031 rules, the property traded must be similar in nature and used for business or as an investment. So, trading primary residences, personal items, or financial assets like stocks or bonds doesn’t work. Also, if the real estate is outside the U.S. or meant to be quickly sold, it doesn’t qualify for a tax-deferred swap.

To qualify under Section 1031, a property’s intent should be for investment or business, not immediate sale. This understanding is crucial for investors looking to benefit from tax deferrals and follow the rules of 1031 exchanges.

Overview of Section 1031 Exchanges

In real estate investment, you can swap one property for another without paying taxes right away. This is known as a 1031 exchange, and it’s covered under the Internal Revenue Code Section 1031. It lets you trade properties used for business or investment. The term “like-kind” means different types of properties can be traded, as long as they are for business or investment.

To make a tax-deferred exchange, you need a middleman called a qualified intermediary. This person holds the money during the swap to keep you from touching it. Touching the money could mess up the tax benefits.

There are two important deadlines in a 1031 exchange. First, after selling your property, you have 45 days to pick new ones you might buy. You need to be clear about which properties you’re looking at. Then, you have 180 days from when you sold your old property to buy the new one.

Requirements Description
45-Day Rule Identify potential replacement properties within 45 days of closing on the relinquished property.
180-Day Rule Complete the acquisition of the replacement property within 180 days of the sale of the relinquished property.
Qualified Intermediary Utilize a third-party entity to handle exchange proceeds and ensure compliance.
Like-kind Property Exchange properties that are of similar nature or character, used for business or investment.
Unambiguous Description Provide clear identification of replacement properties (legal description or property address).

You can pick up to three properties to buy, no matter their price. If you want more than three, their total value can’t be over 200% of your old property’s value. This lets you be flexible in choosing new investments.

Not every property type qualifies for a 1031 exchange. Stocks, bonds, and certain other assets don’t count. Neither do properties meant for quick sale. It’s important to know the difference between personal and real property for these exchanges.

Following the 1031 exchange rules and working with a qualified intermediary can really help. It lets you get the most out of not paying taxes immediately. Knowing how these exchanges work is key to using them well.

Properties Not Used for Business or Investment

Understanding which properties don’t fit a 1031 exchange is key. Primary residences and vacation homes for personal use typically don’t qualify. They must be for investment real estate or business use.

Personal properties or primary residences usually won’t qualify. There are exceptions under Section 121, though. This section allows gains exclusion of up to $250,000 for single filers and $500,000 for joint filers on selling a primary residence. Yet, personal use limits eligibility for a 1031 exchange.

Eligible Properties Non-Eligible Properties
Income-producing real estate Primary residences
Vacant land Vacation homes (primarily for personal use)
Residential rentals Short-term development land

The property must meet the like-kind standard. This usually works for domestic or foreign exchanges. Yet, domestic-to-foreign exchanges do not qualify. Vacation homes used mostly for fun don’t make the cut either.

To ensure you qualify, follow these rules closely. Consulting a real estate tax expert is strongly recommended. They can help with compliance and understanding non-qualifying transactions.

Which of the Following Would Not Qualify as a 1031 Exchange?

It’s important for investors to know what doesn’t count for a 1031 exchange. Personal homes usually don’t get these tax breaks. Likewise, fixer-uppers or empty lots to be developed don’t meet the criteria. This rule also applies to business inventory and stock in trade meant for sale.

An investor who often flips properties may be seen as a dealer. This label means they can’t get the tax benefits of a 1013 exchange. Vehicles, artwork, and intellectual property are also out of the question. Swapping stocks, bonds, or partnership shares is likewise not allowed.

Similarly, vacant land set for development isn’t seen as similar enough to qualify. Knowing these rules helps investors follow the 1031 exchange guidelines. It also helps them avoid unexpected taxes. Being aware of what is not allowed is just as important as knowing what is.

Trading vacation homes might seem complicated at first. Yet, following the rules in Revenue Procedure 2008-16 makes some eligible. Primary homes are usually not included unless part of them is used for business. Keeping up with these details helps investors stay within the law. It maximizes their tax deferral chances while avoiding mistakes.

Recent Changes in 1031 Rules

The Tax Cuts and Jobs Act (TCJA) changed a lot about 1031 exchanges. Now, only real property qualifies for like-kind exchanges. Before, things like franchise licenses and aircraft could also qualify. But, after the TCJA, these items were removed from the list. There was a transition rule for exchanges of qualified personal property completed or started by December 31, 2017.

Investors must now focus on real estate for their exchanges. They also need to follow strict timelines. For example, within 45 days of selling a property, they must pick out potential replacements. Then, they have 180 days to finish buying the new property.

Usually, up to three properties can be marked for acquisition. If more are chosen, their total value shouldn’t be more than 200% of the sold property’s value. If the total is higher, then 95% of their market value must be bought to stick to the rules.

Some costs are considered Exchange Expenses, like title insurance and appraisal fees. But, transfer taxes and property liability insurance don’t count. Real estate businesses need to watch these details closely. This way, they can follow the TCJA rules and still benefit from tax deferals.

The rules got stricter for vacation homes too. These properties must be rented out for at least 14 days a year, for two years. Owners can only use these homes for up to 14 days a year or 10% of the rental days. Also, after exchanging them, the new vacation homes must be held for at least 24 months.

Conclusion

It’s vital for real estate investors to understand like-kind property exchanges. They help avoid taxes on profits if you reinvest. Section 1031 is key for this, as it allows delaying tax on gains. This applies when you reinvest in a similar property. It’s used by various groups, including corporations and trusts.

There are many ways to swap properties under Section 1031. You can switch simultaneously, delay, or even do a reverse exchange. But, some items like stocks or bonds don’t qualify. To avoid mistakes, know the rules about choosing new properties quickly. Also, having a qualified intermediary is a must for a smooth process.

Filing IRS Form 8824 is how you report the exchange. Each deal must follow strict rules to keep the tax benefits. It’s also important to stay updated on laws, like the Tax Cuts and Jobs Act. Smart planning makes it possible to grow your investments. And you can do it while lessening what you owe in taxes.

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About the author

Nathan Tarrant

Nathan has worked in financial services, marketing, and strategic business growth for over 30 years. He was the founder and COO of a Queens award-winning financial services company based in the UK, and a capital investment company in Virginia USA..

He operated as a financial & alternative investment advisor to delegates of the UN, World Health Organization, and senior managers of Fortune 500 companies in Geneva, Switzerland, after the 2008 financial crash.

As an avid investor, especially in alternative investments, he runs this blog Altinvestor.net, sharing his growing experience and views on alternative investments. You can see Nathan's full profile at his personal website nathantarrant.com
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