When selling a business or investment property, a taxpayer is generally subject to tax on ordinary income, capital gain, deprecation recapture and/or a Medicare surcharge (“Obamacare”). Paying these tax liabilities reduces the amount of cash available for reinvestment, making it difficult for a taxpayer to invest in larger, more profitable properties. Internal Revenue Code § 1031 provides for a method to defer capital gains taxes on the sale of business or investment property when a taxpayer reinvests the proceeds of the sale into the purchase of a new business or investment property.
“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.” IRC § 1031(a)(1)
To qualify for § 1031 Like Kind Exchange treatment, the property must be held for rental (income production), investment (capital appreciation) or be used in a trade or business. Properties not held for these purposes will generally not qualify for § 1031. Real estate will most easily fit into these qualifications. Whether you invest in a single-family residential properties, multi-family residential properties, commercial office buildings, retail shopping centers, industrial warehouses or the like, you may exchange between any of the above and qualify for § 1031 Like Kind Exchange treatment as long as the properties were held for investment.
To take advantage of § 1031, you must identify a potential replacement property within 45 calendar days of sale of the property you are relinquishing. You may identify up to three potential properties and they must be identified unambiguously, using one of the following designations: (1) Street address, (2) Legal description, or (3) Assessor’s Parcel Number.
Finally, to complete the § 1031 Exchange Transaction, you must include the receipt of legal title to the replacement property no later than the earlier of: (1) midnight of the 180th calendar day following the close of the relinquished property sale transaction, or (2) the due date to file your Federal income tax return for the income tax year in which the relinquished property was sold, including any extensions.