When a property owner invests their money from a sale into another property, there have been no real economic gains yet. It’s not always easy to determine what kinds of exchanges or transactions will be tax-deferred. Under Section 1031 of the Internal Revenue Code, if a taxpayer exchanges one business or investment asset for another business or investment asset, and no cash was created from the transaction, then the gain will not be subject to immediate taxation. In other words, an investor can sell a property to reinvest its proceeds in a new property, while deferring all capital gains. (Normally in this sort of transaction, the property owner would be taxed on any gain that is realized from the sale.) It is important to note that through a Section 1031 Exchange, the tax on the gain is not forgiven, but rather postponed to a later date.
Not just any kind of property qualifies in this exchange. First, both the property exchanged and the property received must be property that is used productively whether in trade, business or investment — meaning, it must be income producing property. Next, the exchanged properties must be like-kind. Like-kind property describes the nature of the property, not its quality. One class of property cannot be exchanged for a property of a different class.
Certain types of property are specifically excluded from Section 1031 treatment. Section 1031 does not apply to exchanges of:
Inventory or stock in trade
Stocks, bonds, or notes
Other securities or debt
Certificates of trust
While a like-kind exchange does not have to be a simultaneous swap of properties, you must meet two time limits or the entire gain will be taxable.
While these transactions can get confusing, it’s important to make sure you’re following the Internal Revenue Code. 212 Tax can provide you with a C.P.A. who has many years of experience dealing with Section 1031 Exchanges and the tax issues that come along with them.