What is like-kind property?
Like-kind property is not a narrow definition. You may 1031 exchange any property that, under state law, is considered real property for any property that, under state law, is also considered real property. This means you can 1031 exchange a commercial building for an apartment house, since both types of property are considered real property. You can not 1031 exchange real property for any other type of property, such as tangible property (i.e. equipment, automobiles or trucks) or intangible property (i.e. copyrights, trademarks or franchises).
How many properties can I identify?
You can identify up to three properties of any Fair Market Value (FMV). You can identify more than three properties as long as the total combined FMV does not exceed 200 percent of the FMV of the property you sold (Relinquished Property). As a final option, you may identify any number of properties as long as you acquire at least 95 percent of the FMV of the properties you have identified.
How long do I have to hold a property to have it be considered investment property?
In order for your property to qualify for a tax deferred 1031 exchange, it must be “held for investment.” Unfortunately, neither the Internal Revenue Code nor the Internal Revenue Service Regulations provide an exact definition of "held for investment.”
One of the factors that the Internal Revenue Service looks at is the length of time you have held the property for investment. However, neither the Internal Revenue Code nor the Internal Revenue Service Regulations indicate how long you must hold a property for it to qualify as investment property. One source you can look to is a proposed, but not implemented, 1989 Internal Revenue code change. This proposed change required the Exchangor to own the relinquished property for one year, and own the replacement property for one year after the 1031 exchange occurred.
In private letter ruling (PLR) 8429039 the Internal Revenue Service indicated that a two-year minimum holding period would be sufficient. While private letter rulings do not establish legal precedent for all Exchangors, it still gives you an idea of what the Internal Revenue Service is thinking.
Another source you can look to is a tax court case in which the Exchangor held their Relinquished Property for five months and twenty days (six months). The Tax Court deemed this period sufficient to be considered "held for investment".
Most advisors recommend the Exchangor hold the Relinquished Property and Replacement Property for at least twelve months. This recommendation is made for two reasons. The first reason is that a holding period of twelve months or more usually results in the Exchangor reporting the property on two different filing periods on their income tax returns. The second reason is that it reflects the holding period in an Internal Revenue Code change proposed, but not passed by Congress. The Internal Revenue Service will also look at all of the facts and circumstances concerning the Exchangor's situation to determine whether the Exchangor intended to hold the Relinquished and Replacement properties “for investment.”
Can I immediately move into the replacement property that I acquire?
You cannot move into the property you acquire to replace the property you sold. If you do, it will not qualify as your Replacement Property. Moving into a Replacement Property would convert it into a principal residence which is a personal use property. If you rent out your replacement property for one to two years, you can then move into your replacement property.
Can I purchase my replacement property from a related personal or business entity?
No. We do not recommend you purchase your Replacement Property from a related person or business. We do not believe the Internal Revenue Service currently favors this type of a 1031 exchange, even if the Exchangor or the Entity - person, partnership, or corporation - that accomplishes a tax deferred 1031 exchange uses an Accommodator.
What forms should be used to indicate my intent to begin or complete a 1031 exchange?
You should use California Association of REALTORS® Form SES-11
to indicate your intent to sell your Relinquished Property (to download a sample copy of SES-11, click here
) and Form BES-11
to indicate your intent to buy your Replacement Property.
How do I report a tax deferred 1031 exchange on my income tax return?
You should use Internal Revenue Service Form 8824
Like-Kind Exchanges to report your tax deferred 1031 exchange in the year you sold the Relinquished Property.
If I am an Individual Seller and enter into a tax deferred 1031 exchange, is it necessary to have California tax withheld?
If you complete California Form 593-C
, Real Estate Withholding Certificate for Individual and Non-Individual Sellers (to download a copy of Form 593-C, click here
) and submit it to your Escrow Company, you will be exempt from the California Franchise Tax Board withholding procedures. The Escrow Company handling the Relinquished Property will no longer be liable for withholding California tax. However, you will be subject to withholding at 3 1/3% on any cash you receive from the Accommodator at the end of the 1031 exchange.
Can I 1031 Exchange My Vacation Home?
We frequently get questions about whether a vacation home can be used in a 1031 Exchange. Vacation homes may qualify for a 1031 exchange if the taxpayer's use of the home is minimal and the property is also rented.
On February 15, 2008, the Internal Revenue Service issued Rev. Proc 2008-16, which issued more stringent guidelines for 1031 exchanging vacation homes.
The relinquished property must have been owned for 24 months immediately before the 1031 exchange.
In each 12 month period before the 1031 exchange, the taxpayer must rent the relinquished property for 14 days or more, at a fair market rate.
The taxpayer’s personal use of the property cannot exceed the greater of 14 days or 10% of the days rented in either 12 month period.
Furthermore, the replacement property must be owned for 24 months immediately after the 1031 exchange.
In each 12 month period after the 1031 exchange, the taxpayer must rent the replacement property for 14 days or more, at a fair market rate.
The taxpayer’s personal use of the replacement property cannot exceed the greater of 14 days or 10% of the days rented in either 12 month period.
In summary, a vacation home must be owned two years before a 1031 Exchange can be used, and two years after the 1031 exchange has been completed. Additionally, the property must be rented for at least 14 days in each of the four years. These guidelines represent a more onerous requirement then was previously expected in the 1031 exchange of vacation homes.