Exchange of Real for Personal Property

When an investor sells one investment property and buys another, the capital gains tax is postponed under the terms of a 1031 exchange. Estate agents, title firms, entrepreneurs, and even soccer mothers all use this word, which receives its name from Section 1031 of the Internal Revenue Code (IRC). Some people are so set on turning it into a verb that they say things like “Let’s 1031 that building for another.” Investors in real estate need a thorough understanding of IRC Section 1031 before trying to use it. Internal Revenue Service (IRS) regulations restrict the use of exchanges for vacation properties since they can only be made between like-kind property. There could also be issues with timing and tax effects.

A 1031 exchange, also known as a resembling swap or a Starker transfer, is the process of exchanging one investment property for another of the same type. Even though most exchanges are taxed as purchases, if your exchange satisfies the requirements of Section 1031, you may owe no tax or just a minimal amount of tax at the time of the transfer. In essence, you can convert your investment to a different form without (in the eyes of the Internal Revenue Service) cashing out or reporting a gain. As a result, your money can keep growing tax-free. You may perform a 1031 exchange as often as you choose. The profit you make on one investment property can be used to buy another, and another, and another. Taxes on any gains from swaps are deferred until they are ultimately realized in a cash sale. The long-term capital gains rate is now 15% or 20%, based on income, and will be 0% for some lower-income taxpayers as of 2022). Most transactions only need to be “of like-kind,” a word whose meaning is obscure and often overlooked. Apartment complexes can be traded for farms, and ranches for shopping centers. Surprising laxity in the regulations. Even trading one company for another is possible, albeit not without potential pitfalls. While the 1031 provision is intended for commercial and investment properties, a former primary dwelling may qualify for the rules under specific circumstances. More on how to use 1031 to transfer vacation properties below, but know that this loophole is significantly smaller than it once was.

As a rule of thumb, “real property” refers to actual land or buildings. The land and any structures, fences, gardens, roads, sewers, or drains that are permanently installed on it are included. Vehicles, animals, cash, and household furnishings are all examples of “personal property,” which is to say, non-real property.

Contract exchange occurs when the buyer and seller physically give and receive each other’s copies of the necessary paperwork to finalize the sale of real estate. Once agreements are exchanged, the sale is finalized at the agreed upon price, and neither the buyer or the seller cannot back out without severe financial repercussions.