1031 Like-Kind Exchange Requirements

What are 1031 Like-Kind Exchange Requirements?

What are 1031 exchange requirements?

Tax deferred exchanges are authorized by Section 1031 of the Internal Revenue Code and the requirements of the code section and the corresponding regulations must be carefully met.  When the like-kind exchange is done properly, the tax on the transaction is deferred.

The following are some of the specific requirements:

Like-kind requirement

Taxpayers must exchange properties that are of like-kind.  Generally, all real estate is like-kind to other real estate.  For personal property, the like-kind assets may be classified by a General Asset Class (GAC) and if not matched there, then by North American Industry Classification System (NAICS) Product Class. If the personal property assets are not found in the GAC or NAICS, then a general like‐kind analysis may be made.

Purpose requirement

Assets to be exchanged must have been held for productive use in a trade or business or held for investment.

Holding requirement

There is no holding period that is specifically defined in Section 1031 or the regulations.  Generally, a rough rule of thumb is a holding period of two years or more. The holding period is considered in determining whether the purpose requirement has been met. For example, if a replacement property is acquired and immediately sold, that might indicate the property was acquired for resale and is therefore dealer property or inventory and cannot qualify for tax deferred treatment under Section 1031.

Exchange requirement

An exchange must take place in which one property is exchanged for another of like-kind.  More than one property may be sold or acquired through a 1031 exchange.

Time limits & identification requirement

A taxpayer is required to acquire or identify the target replacement property within 45 days after the transfer of the relinquished property. Properties acquired within the 45-day designation period are deemed to be identified.  Replacement property must be designated in a written document, unambiguously described, signed by the taxpayer and received by the qualified intermediary on or before the 45th day.

If the taxpayer identifies replacement property within the designation period, the exchange period end date may be extended up to 180 days from the transfer of the first relinquished property.  This provides the taxpayer additional time to complete the exchange, however, it might be necessary for the taxpayer to file a tax-filing extension in order to utilize the full 180 days.

No constructive or actual receipt of exchange funds

It is a violation if the taxpayer or an agent for the taxpayer receives exchange funds or the taxpayer is directly or indirectly able to control the exchange funds during the exchange period.

Use of a qualified intermediary

An unrelated third party or “qualified intermediary” (QI) may be used to facilitate the 1031 exchange transaction.  A taxpayer cannot utilize their Realtor®, lawyer, accountant or a related party as a QI.  Additionally, several states require that QIs be compliant with regulatory requirements regarding insurance, bonding, and the manner in which exchange funds are held, state licensing, etc.

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