Section 1031 of the Internal Revenue Code allows a real estate investor or an owner of an investment property to exchange their property, thus deferring payment of state and federal capital tax gains. This is applicable if they purchase a “like-kind” property that adheres to the regulations and rules of the IRS 1031 exchange. This will allow the investor to use all of the proceeds from the sale to acquire a more valuable real estate holding, diversify into other properties, increase their cash flow, or consolidate into one property to reduce management tasks.
One major point to understand is what qualifies as a 1031 like kind property. The IRS states that in order to qualify, an investor shall incur no loss or gain on the exchange. A few examples of properties that can be exchanged include duplexes, single family residences, commercial properties, apartments and even raw land. For instance, you can exchange an apartment rental for a single family home rental, commercial building, etc.
Another benefit under a Section 1031 is that the exchange does not have to be simultaneous. Many are delayed exchanges, as you have 180 days in which to complete the transaction. However, in order to use the 1031 property exchange you must identify your potential replacement property within 45 days of closing on the original property.
It is also possible to sell a property under the 1031 exchange property code that has been used for both residential and business purposes. The major requirement is that a clear distinction must be present in the records of the taxpayer, with regard to the property that has been used for business versus the portion that is for personal use. One example of this that would be allowed under the 1031 exchange real estate rules is a bed and breakfast, and using the property as part personal residence and part business property. The same principal applies for the taxpayer who deducts a portion of his or her residence for a home office, as it is considered business usage.
If you need an effective strategy when selling a primary residence that has quite a bit of excess land around the personal residence, then Section 1031 is the tool you need; if you have been using it as an investment property. For instance, let’s say the taxpayer has a personal residence that is on 30 acres of land, yet similar properties in the area have been determined to be an average of only 5 acres in size. The 1031 exchange rules will allow the owner to use the extra 25 acres in an exchange.