Broker Check

Separating Fact from Fiction with 1031 Exchanges

March 06, 2024

Sophisticated investors have long utilized 1031 exchanges as a strategic tool to defer capital gains taxes. Despite its century-old legacy, several prevailing myths still shroud the essence of these exchanges. These misconceptions not only dissuade investors from harnessing the advantages of engaging in a 1031 exchange but could also potentially lead to substantial financial setbacks if believed. Below, we debunk five common misconceptions and unravel the facts you need to navigate this tax-deferral strategy effectively.


  1. 1031 Exchanges Are Deemed "Not Legal"

Despite sounding too good to be true, 1031 exchange transactions are entirely legitimate. Established under Section 1031 of the U.S. Tax Code, these exchanges have been a part of the investment landscape since 1921. You can find detailed information about the legality and regulations surrounding 1031 exchanges in recent IRS Fact Sheet 2008-18.


  1. Only "Commercial" Properties Qualify for a 1031 Exchange

While "commercial" properties like retail buildings are frequently involved in 1031 exchanges, the eligibility extends beyond this realm. Residential rental properties, undeveloped land, and various other business and rental properties are also eligible for 1031 exchanges.


  1. Your Advisor Can Serve as Your Qualified Intermediary (QI)

Contrary to popular belief, appointing your accountant, attorney, or real estate broker as your QI could jeopardize your exchange. IRS rules mandate an independent relationship between the investor and the QI. This means ensuring the QI is a disinterested third party, not a disqualified person like yourself, relatives, or anyone who has represented you within the preceding two years. While professionals like attorneys or accountants can serve as QIs, they must not have any prior or ongoing involvement with your transaction. Additionally, some states impose specific regulations on QIs, such as licensing and insurance requirements.


  1. Replacement Properties Must Match Exactly with the Relinquished Property

While IRS regulations require replacement properties to be "like kind" to the relinquished property, the definition of "like kind" is more expansive than commonly perceived. According to the IRS, any type of real estate in the U.S. is considered like-kind to any other type. This allows for diverse exchanges such as commercial buildings for vacant land, storage facilities for hotels, or industrial properties for ranches, as long as both properties are held for productive use in business or investment.


  1. A Minimum Holding Period is Required Before Exchanging Properties

It's widely believed that a replacement property must be held for at least two years to avoid disqualification of the 1031 exchange. While the IRS's "safe harbor" provision in Revenue Procedure 2008-16 suggests a two-year holding period, the IRS hasn't explicitly stated a mandatory holding time. Holding the replacement property for two years may provide a safe harbor and bolster the legitimacy of the exchange. However, if an exceptional offer arises earlier, the two-year timeframe should not dictate your investment decisions. Selling before the two-year mark might prompt IRS scrutiny to confirm the property's intended use for business or investment. Consulting tax and legal professionals regarding property holding periods is advisable due to the multitude of variables involved.


Scott Offerman helps investors navigate obstacles and fix problems which commonly occur during a Real Estate Investment Sale utilizing a 1031 Exchange.


Scott Offerman

Founder

1031 Financial

scott@1031financial.com

Cell: 917-887-0166

www.1031financial.com

By Appointment Only

321 West 44th Street, Suite 200

New York, NY 10036