1031 Exchange Tax Rules
Section 1031 of the Internal Revenue Code (IRC) requires the knowledge of many 1031 exchange tax rules. Violation of just one can jeopardize the tax deferral. In addition to the federal requirements, each state can legislate their own requirements as have Washington, Oregon, California, Idaho, Nevada, Colorado, Virginia and Maine. The state provisions focus on the protection of their constituents and how to best filter the 1031 exchange accommodator, or qualified intermediary, by defining minimum insurance requirements and how exchange funds are protected.
Intent and Facts
1031 exchange tax rules start with intent at the time the exchange is initiated, and the facts that support the intent and exchange. The proper 1031 intent as defined by the IRC as “property held in a trade, business or investment”. Property held primarily for personal use is not eligible for 1031 consideration. In addition, the following are not eligible for 1031 consideration.
- Primary residence
- Stocks, securities and bonds
- Partnership interest
However, the use of a primary residence can be converted and held as a rental, making the property eligible for a 1031 exchange.
Good facts supporting proper 1031 intent include:
- Property is rented a minimum of 14 overnights per year at fair market rate
- Property is held for two years, though a minimum of one year is highly suggested
- Property is held for rental
- Property is depreciated and reflected on the appropriate federal tax form.
The 1031 exchange tax rules for property reflect the requirement that the property must be exchanged for “like-kind” property. Real and personal tangible and intangible property are eligible for 1031 consideration. Real property can be exchanged for any real property given the duration of interests is perpetual and both the old and new properties are located in the United States. Real property located overseas is exchangeable for any real property located internationally.
The exchange of personal property requires the property to be in the same class of asset. Thirteen general asset classes and the North American Standard Industry Classification Code classify the asset’s class. The exquisite violin owned and used by a chamber musician in their trade cannot be exchanged for an oil painting or vintage motor car. Each must be exchanged for “like-kind” property within the same class.
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