Benchmark Title Company, LLC

 

What Does Not Qualify for a 1031 Exchange?

Sarah Holdener

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:  

John Howe
President

Doreen Miller, Esq.
Commercial Division Manager

Sarah Holdener, Esq.
General Counsel,
VP Production

Michelle Null
VP Escrow Operations


Serving you from three convenient locations:

Main Office:
1124 Hartman Lane
Shiloh, IL 62221
Ph: 618-239-3750
Escrow Fax: 618-239-3707
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President: John Howe
www.benchmarktitle.net

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Glen Carbon, IL 62034
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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.


Save the Date!

Our Glen Carbon branch has been serving you for 2 years.   Mark October 4th on your calendar and plan to join us 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 ssowell@benchmarktitle.net, or Bethany at bbond@benchmarktitle.net.  We hope to see you there!


 
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