Which type of property does not qualify for 1031 exchange?

Question

What types of properties are ineligible for a 1031 exchange under the current IRS regulations, and what are the specific characteristics or uses of these properties that disqualify them from being considered like-kind for the purposes of tax deferral?

ARTE's Answer

When considering a 1031 exchange, it's crucial to understand which types of property qualify and which do not. The essence of a 1031 exchange is to defer capital gains taxes by exchanging like-kind properties held for productive use in a trade or business or for investment. However, not all properties are eligible for this tax-deferral benefit.

Properties That Do Not Qualify for a 1031 Exchange:

  1. Personal Use Property: Real estate held primarily for personal use, such as your primary residence or a vacation home, does not qualify for a 1031 exchange. The IRS requires that both the relinquished and replacement properties be held for investment or business purposes.
  2. Property Held Primarily for Sale: This includes inventory or stock in trade, such as properties held by developers or flippers. These properties are considered inventory and are not eligible for 1031 exchanges.
  3. Securities and Bonds: Stocks, bonds, or notes are explicitly excluded from 1031 exchange treatment. These are considered personal property and do not meet the like-kind requirement for real property exchanges.
  4. Partnership Interests: Interests in a partnership, whether general or limited, do not qualify for a 1031 exchange. This is because partnership interests are considered personal property, not real property.
  5. Foreign Property: Real property located outside the United States is not considered like-kind to property located within the United States. Therefore, exchanges involving foreign real estate do not qualify for 1031 treatment.

Example to Illustrate:

Let's say you own a rental property in the U.S. that you purchased for $200,000, and it's now worth $400,000. You want to defer the capital gains tax on the $200,000 gain by engaging in a 1031 exchange. You decide to use Deferred.com as your qualified intermediary to facilitate the exchange.

You identify a replacement property, another rental property in the U.S., valued at $450,000. This exchange would qualify for 1031 treatment because both properties are held for investment purposes, and the replacement property is of equal or greater value.

However, if you were to attempt to exchange your U.S. rental property for a vacation home in the Bahamas, this would not qualify for a 1031 exchange. The vacation home is considered personal use property, and the foreign location further disqualifies it from being like-kind to your U.S. rental property.

At Deferred.com, we ensure that your exchange meets all IRS requirements, helping you navigate the complexities of 1031 exchanges. Our "No Fee Exchange" service is designed to save you money while providing expert guidance throughout the process. If you have any questions or need assistance with your exchange, we're here to help.

Have more questions? Call us at 866-442-1031 or send an email to support@deferred.com to talk with an exchange officer at Deferred.

Deferred's AI Real Estate Tax Expert (ARTE) is a free research tool. Trained on 8,000+ pages of US tax law, regulations and rulings, ARTE outperforms human test takers on the CPA exam. This is page has ARTE's response to a common 1031 Exchange question and should not be considered personalized tax advice.

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