Internal Revenue Code §1031
IRC §1031 provides an exception from the general rule requiring the current recognition of gain or loss realized upon the sale or exchange of property. Under §1031(a), no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged solely for property of a like kind to be held either for productive use in a trade or business or for investment.
Attorney, Darby Smith, has practiced real estate law for over 15 years. Additionally, Darby has an LL.M (Masters of Law) in Taxation from New York University School of Law. If you are interested in effectuating a §1031 Like-Kind Exchange, contact Darby Smith to help you prepare the transaction properly to achieve maximum tax deferral.
- Exchange Property must be held for productive use in a trade or business or for investment;
- There must be an exchange of qualifying property (as opposed to a sale);
- The exchanged property must be of “like-kind.”
- Gain must be recognized under §1031(b) to the extent of “boot.” If an exchange would be within the provisions of §1031(a) but for the fact that the property received consists of qualifying property and other property or money, the gain, if any, to the recipient is recognized to the extent of the sum of the money and the fair market value of the other property received. This “money or other property” is commonly called “boot” and includes liabilities assumed (or a transfer subject to a liability).
- A deferred exchange is defined under §1.1031(k)-1 as an exchange in which, pursuant to an agreement, the taxpayer transfers property held for productive use in a trade or business or for investment (the “relinquished property”) and subsequently receives property to be held either for productive use in a trade or business or for investment (the “replacement property”);
- In the case of a transfer of relinquished property in a deferred exchange, gain or loss must be recognized if the taxpayer actually or constructively receives money or other property before actually receiving like-kind replacement property. Furthermore, if the full amount of the consideration for the relinquished property is actually or constructively received before the like-kind replacement property is received, the transaction is considered a sale rather than a deferred exchange, even though like-kind replacement property is ultimately received by the taxpayer.
- §1031(a)(3) provides that the Replacement property must be identified within 45 days after the date on which the taxpayer transfers the property relinquished in the exchange and such property must be received before the earlier of (i) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, or (ii) the due date (determined with regard to extensions) for the transferor’s return for the taxable year in which the transfer of the relinquished property occurs.
- SAFE HARBORS – the “(g)(6)” Restrictions.
- In an effort to provide clear rules for some typical deferred exchange transactions, the regulations provide four safe harbors which state that certain issues, such as agency and constructive receipt, will, in effect, be ignored for purposes of determining whether the taxpayer is in actual or constructive receipt of money or other property before the taxpayer actually receives like-kind replacement property.
- Under the third safe harbor, the taxpayer’s transferee may use a “qualified intermediary” provided the taxpayer’s rights to receive money or other property from the qualified intermediary are limited to the circumstances specified in Treas. Reg. § 1.1031(k)-1(g)(6).
- A qualified intermediary is a person who is not the taxpayer or a “disqualified person” and enters into an agreement (“exchange agreement”) with the taxpayer and, as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and transfers the replacement property to the taxpayer.
- Consistent with Rev. Rul. 90-34, the transfer of property in a deferred exchange that is facilitated by the use of a qualified intermediary may occur via a “direct deed” of legal title by the current owner of the property to the ultimate owner.
IRS Circular 230 Regulations: As a result of perceived abuses, the Treasury has recently required us to inform you that any tax advice contained in this communication (including attachments) may not be relied on to avoid tax penalties under the IRS code or for promoting, marketing or recommending to another party any transaction or matter addressed herein.