What is Section 1031 and What Real Estate is Not Eligible For It?


What is Section 1031 and What Real Estate is Not Eligible For It?

If you are selling a real estate property that has gained value over time (and let’s face it, most properties these days fall into this category), you will have to pay taxes on the appreciation. Section 1031 of the Internal Revenue Code allows some real estate profits to be tax-deferred if they meet specific criteria. What real estate is not eligible for Section 1031?

First, let’s take a deeper look at what Section 1031 is, and what does quality for this tax deferment. Section 1031 allows for the deferral of capital gains taxes on investment properties or business properties. Section 1031 creates a benefit that is meant to encourage continued investment in these types of properties by allowing taxpayers to avoid a large tax bill immediately upon the sale of a property. The caveat is that only “like kind” properties quality for a 1031 exchange. This means that the seller must use the sales proceeds toward the purchase of a similar property, and both the new and old properties must meet certain requirements.

While many properties can be classified as “like kind,” a 1031 exchange excludes many properties. Reasons a property might be ineligible include:

  • The property is for personal use. This includes primary or secondary residences or vacation homes, even if they are sometimes rented out. Only investment or business properties are eligible for a 1031 exchange.
  • The property is being held by a real estate developer for the sole purpose of selling it. Only properties that are owned for at least 2 years and for the purpose of investment qualify.
  • The properties are not “like kind.” There can be many reasons the 2 properties are not considered comparable. For example, properties that are located outside of the United States do not qualify. Properties that do not include the land are not “like kind” to a property that does include land ownership.
  • It is intangible property like mineral rights or air rights.

The rules and regulations surrounding 1031 exchanges are complex; it’s advisable to consult with a Section 1031 professional to determine if a real estate transaction is eligible or not. It’s especially important to do so before beginning the selling or buying process since documentation for the IRS must begin prior to the time that any transactions are initiated.

Clear Title is a full-service title company, with deep knowledge of Section 1031 of the Internal Revenue Code. To get help with your 1031 exchange, please call one of our offices today.

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