The classification of properties exchanged determines if the property qualifies for Section 1031

A. The IRS's 4 classifications of Real Estate:

    Property held for personal use. (Personal Property)

    Property held primarily for sale. (Dealer Property)

    Property held for productive use in a trade or business. (Business Property)

    Property held for investment. (Investment Property)

  • The last two qualify for Section 1031 tax deferral, the first two do not. Both the property received and the property sold must be of "Like Kind".
  • It is your use of the property that determines its classification.
  • What the other party does with the property does not affect your tax status.

B. Like-Kind Property

    Like-kind refers to your use of the property and not to its grade or quality.

    "1031" property may be mixed as to type and still be like-kind.

    As an example, you may exchange land for a duplex, or a commercial building for a retail store, etc.

    Property held outside the USA and its territories does not qualify for exchange with property held within the USA.

C. Partnership Interests

    Your interest in a partnership cannot be traded for an interest in another partnership.

      Exception:

    The partnership as an entity can exchange real estate it owns for other like-kind real estate.

D. Transfer Between Spouses

    There are no income tax consequences in entering into financial transactions between spouses.

    In addition, most transfers incident to a divorce are tax free.

    However, transactions with a former spouse are normally subject to tax unless they qualify for non recognition under the provisions of Section 1031.

E. Sale/Lease Back As An Exchange

    A lessees interest in a lease with a term of 30 years or longer in real property is considered like-kind to other real property.

    In addition, property which is subject to a lease can be, even if the lease is for a term of 30 years or longer, the subject of a tax free exchange.

    However the receipt of prepaid lease payments in an exchange for a 30-year or longer lease is taxed as ordinary income and will not qualify for tax-free exchange treatment.

F. Business Assets

    The personal property assets of one business can be exchanged for like-kind assets of another business and will be held as a like-kind exchange under Section 1031.

    The real property is treated the same as any other exchange.

    The like-kind requirements for personal property are much more stringent than for real property (e.g., a truck cannot be exchanged for a car, nor can a barge be exchanged for a cargo ship).

G. Vacation Homes & Properties

    This type of property does not qualify if it is used solely for personal use. 

    It may qualify if rented, and must pass a use test each year.

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