What Does Not Qualify for a 1031 Exchange?
You may recall my Title Tip from last
April on “1031 Tax Deferred Exchanges” explaining the concept and basic
procedure for completing an exchange of property that qualifies for tax
deferral under Section 1031 of the Internal Revenue Code. That Tip can
be found at http://www.benchmarktitle.net/pages/040607.htm. In
that Tip we discussed briefly what sort of property may qualify for a 1031
exchange, but sometimes the easiest way to define something is by describing
what it is not, and so today we discuss what types of property do not qualify
for tax deferral under Section 1031.
The IRS gives four classifications of Real Estate:
(1) Property held for personal use
(2) Property held primarily for sale
(3) Property held for productive use in a trade or business
(4) Property held for investment
The last two categories qualify for Section 1031 tax deferral, but the first
two do not. Properties exchanged must be of like-kind, which is defined
as property held for productive use in a trade or business or for investment
that is exchanged solely for similar property. The term
"like-kind" is often thought to mean that one type of property must
be traded for the exact same property type, but that is incorrect. Any real
property held for investment or used in a trade of business can be swapped
for any other property held for investment or used in a trade or business.
Properties are of like-kind, if they are of the same nature or character,
even if they differ in grade or quality. Personal properties of a like class
are like-kind properties. However, livestock of different sexes are not
like-kind properties. Also, personal property used predominantly in the
United States and personal property used predominantly outside the United
States are not like-kind properties.
One question we frequently hear is whether a personal residence qualifies for
1031 treatment. Normally, residential property that is not rented and
does not otherwise produce income does not qualify as "investment
property," so the short answer is no. But there are circumstances
where a residence or vacation home may be converted to investment property,
or where a true investment property is exchanged into a vacation or second
home. If you are considering seeking tax deferral for an exchange involving
property that has been or will be used as a personal residence or a second or
vacation home, we recommend you seek the advice of a tax specialist and legal
counsel before proceeding.
If you are considered a “dealer”, you will also typically not qualify for
1031 exchange treatment because you are technically holding the property for
sale as “inventory” and thus not for investment purposes. In some
cases, however, dealers may be able to qualify for 1031 exchange treatment by
segregating assets intended to be held as rental, investment or productive
use in a trade or business from those assets being held for sale. In
these situations, some legal advisors have advised their clients to form a
separate entity, such as a limited liability company, specifically to hold
title to the segregated property in order to more easily qualify for 1031
exchange treatment in the future.
If however your intent is to buy, fix up and then sell (“Flip”) the property,
then you clearly do not have the intent to hold the property for investment
purposes. Rather, the intent is to hold the property for sale, and
accordingly will not qualify for 1031 exchange treatment.
Again, these are just the basics and certainly not a definitive list of what
does not qualify for 1031 treatment, which is why it's imperative to first
consult with your tax or legal advisor before beginning a 1031 tax deferred
exchange. While Benchmark Title is ready and able to serve as the
Qualified Intermediary for your clients' 1031 Tax Deferred Exchange, we recommend
that anyone contemplating a 1031 Exchange also retain a tax attorney or
accountant to ensure that the transaction qualifies for tax deferral under
the Internal Revenue Code and makes fiscal sense for the taxpayer.
Any questions can be directed to Benchmark Title at 618-239-3750. Please feel
free to call or email:
Serving you from three convenient locations:
1124 Hartman Lane
Shiloh, IL 62221
Escrow Fax: 618-239-3707
Title Fax: 618-239-3757
Fax Orders: 618-310-1589
President: John Howe
318 North Main St.
Columbia, IL 62236
4215 S. State Rte 159
Glen Carbon, IL 62034
Manager: Sara Sowell
Isn't it Ironic?
Just days after sending our Title Tip on recognizing and preventing
Title Insurance Claims, Benchmark Title was recognized by one of our
underwriters with a Quality Achievement Award in recognition of
outstanding dedication in preventing title claims in Illinois.
Our Glen Carbon branch has been serving you for 2 years.
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for drinks and hors d'oeuvres from 5:00 - 7:00pm in our Glen Carbon
office to celebrate the occassion. Please RSVP to
618-288-1695 or by email to Sara at firstname.lastname@example.org, or
Bethany at email@example.com.
We hope to see you there!
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