A 1031 exchange is an excellent tax-deferral strategy used by real estate investors across the United States. 1031 is a section of the Internal Revenue Code that permits investors to sell property held for business or investment use and to exchange into new business or investment properties while deferring capital gains taxes on the sale. This post will go over the usage of a property that would qualify for a 1031 exchange.
Note: You must set-up an exchange prior to closing on a property for the exchange to be valid. It is important to note that the following are scenarios that different taxpayer entities may encounter in regards to partnerships and setting up a 1031 exchange. Please visit our website at midland1031.com or call (239)-333-1031 to see if your investment, business, or rental property qualifies today.
Qualifying Property in a 1031 Exchange
Properties that qualify for the 1031 exchange must be considered “Real Property” and used for rental, investment, or income-producing purposes to be eligible for a tax-deferred exchange. Raw land, rental condominiums, rental houses, and commercial property can all be considered for a 1031 exchange investment property.
As a general rule, properties used as primary or secondary residences do not qualify for a 1031 exchange. Both the property being sold (relinquished property) and the new property must be for rental or investment use. Vacation homes can sometimes qualify, depending on the period you personally used the property.
The Internal Revenue Service (IRS) section 1031 does not explicitly state the required holding period for properties bought and sold in a 1031 exchange. However, a 24-month safe harbor rule states the IRS will not challenge the qualified use of a property if held for at least that period.
The Exchangor would need to show that they had proper intent for using the property as a rental or investment. Most CPAs/tax advisors would suggest owning the property for 1-2 years before doing a 1031 exchange on the property.
With a 1031 exchange, you are allowed to vacation in the property for 10% of the amount of time that you rent it out, or for 14 days a year if you rent the property out at fair market value for 14 days. Whichever is more significant between those two options is how long you qualify to vacation in your 1031 exchange property each year.
Example: You own a rental beach condo that you rent out for 300 days at fair market value in a year. 10% of 300 is 30, so you would be allowed to use the property for 30 days that same year. The property would still qualify for the 1031 exchange.
Fix and Flips
Properties bought and sold as fix and flips, meaning properties purchased, renovated, and then immediately sold for a profit, would not qualify for a 1031 exchange. The property must be used as a rental or income-producing property and must show the proper intent and a longer holding period.
Sometimes there is confusion on the definition of “Investment” for the purposes of a 1031 exchange. In the exchange, if the property is improved, it must be held for the production of income such as using it for business purposes or renting the property out.
If you own unimproved land, such as a vacant lot, this can also qualify for a 1031 exchange. If you use the property personally as a primary or secondary home, it will not be eligible for the 1031 Exchange.
Other types of exchanges include a delayed exchange, reverse exchange, and improvement exchange. To learn more about 1031 exchange guidelines such as net selling price, qualified intermediaries, and the 45 day rule and 180 day rule call Midland 1031 at (239) 333-1031 or visit our website.
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Written by Alex Moore
1031 Exchange Department