Rule 1: Like-Kind Property

Like-Kind Property:

the term "like-kind" refers to properties of the same nature, character, or class. Generally, most real estate used for business or investment purposes qualifies as like-kind to other real estate. For example, you could exchange an apartment building for raw land, or a commercial property for a warehouse, as long as both are held for investment or business use and are within the U.S.

Would be allowed examples:

Exchanging an apartment building for a duplex or raw land;

Exchanging a single-family rental property for a commercial office building;

Exchanging a rental property or vacation rental for a restaurant space;

Exchanging a commercial property for a warehouse, as long as both are held for investment or business use and are w/in the U.S.

Rule 2: Investment Or Business Property Only

A 1031 exchange is only applicable for investment or business property, not personal property.

In other words, you cannot swap one primary residence for another.

For example:

If you moved from CA to Georgia, you could not exchange your primary residence in CA for another primary residence in Georgia.

If you were to get married and move into the home of your partner, you could not exchange your current primary residence for a vacation property.

Rule 3: Greater Or Equal Value

To avoid paying taxes upon the sale of property, the IRS requires the net market value and equity of the property purchased be the same as, or greater than, the property sold to be able to defer 100% of the tax.

For example:

you have a property worth $2,000,000 and a mortgage of $500,000:

For full benefit of the 1031 exchange, the new property (or properties) you purchase need(s) to have a net worth of at least 2 million dollars, and you will have to carry over at least a $500,000 mortgage.

Note:

the $2,000,000+ value, and $500,000 mortgage can go towards one apartment building or three different properties with a total value of $2,000,000+.

FYI:

Acquisition costs, such as inspections and broker fees, also apply toward the total cost of the new property.

Rule 4: Must Not Receive “Boot”

A Taxpayer Must Not Receive “Boot” in order for the exchange to be completely tax-free.

Any boot received is taxable to the extent of the gain realized on the exchange.

In other words, you can carry out a partial 1031 exchange, in which the new property is of lesser value, but this will not be 100% tax-free.

The difference is called “Boot,” which is the amount you will have to pay capital gains taxes on.

This option is completely okay and often used when a seller wants to make some cash and is willing to pay some taxes to do so.

For example:

if your original property is sold for $2,000,000 and the property you wish to exchange under section 1031 is worth $1,500,000, you would need to pay capital gains tax on the $500,000 “boot.”

Rule 5: Same Tax Payer

The tax return and name appearing on the title of the property being sold must be the same as the tax return and titleholder that purchases the new property.

exception:

occurs in the case of a single-member limited liability company (“smllc”), which is considered a pass-through to the member; therefore, the smllc may sell the original property and that sole member may purchase the new property in their individual name.

For example:

the single member of “Joe Colt LLC” is Joe Colt. Here, the LLC can sell the property owned by the LLC, and because Joe Colt is the sole member of the LLC, he can purchase property in his name and be in compliance with the 1031 code.

Rule 6: 45-Day Identification Window

The property owner has 45 calendar days, post-closing of the first property, to identify up to three potential properties of like-kind.

exception:

the 200% rule

you can identify four or more properties as long as the value of those four combined does not exceed 200% of the value of the property sold.

Rule 7: 180-Day Purchase Window

It is necessary the replacement property is received and the exchange completed no later than 180 days after the sale of the exchanged property OR the due date of the income tax return (with extensions) for the tax year in which the relinquished property was sold, whichever is earlier.