Real estate exchanges are an invaluable tool for agents to create opportunities for additional commissions. Many clients are enthusiastic about deferring capital gains taxes while exchanging for a desired property. As this procedure increases in popularity, many varying opinions surface regarding what properties qualify for a "like-kind" exchange. The Internal Revenue Code Section 1031 (a) (1) says, "no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged solely for property of a like kind to be held either for productive use in a trade or business or for investment." What does the code really mean? Property that is held for investment can be exchanged for any other property that is being held for investment and the investor will be allowed to defer paying capital gains taxes.

What are some properties held for productive use in a trade or business or for investment? The list would include raw land, motels, office buildings, apartments, warehouses, and single family rentals to name a few. The way the code reads, any combination of these properties can be exchanged. That means an apartment can be exchanged for an office building, a warehouse exchanged for a motel, and finally raw land exchanged for a single family rental. In an exchange of real property for real property, the fact that any real property is improved or unimproved is immaterial, because that fact relates only to the grade or quality of the property and not to its kind or class.

Section 1031 does specifically mention properties that will not qualify for tax deferral in an exchange. These would be "stock in trade or other property held primarily for sale; stocks, bonds, or notes; other securities or evidences of indebtedness or interest; interests in a partnership; certificates of trust or beneficial interests; or choses in action." Land that is developed to be subdivided into many parcels and sold piece by piece will not qualify. Properties that are acquired and immediately marketed for sale can be considered as property held "primarily for resale" and not for investment. These will not qualify. Partnership interests are viewed as an ownership in a partnership and not in the underlying real property and are disqualified under the code. Partnerships as a whole can be exchanged, and partnerships can be dissolved to create a situation where each owner can choose to exchange or be cashed out. Planning with competent tax counsel can help to avoid the pitfalls of properties that do not qualify.

With an understanding of the like-kind qualifications of Section 1031, many options are available to agents and their clients. Here are a few ideas:

1. Exchange from a property which cannot be refinanced to improved property. This will
give the exchangor the ability to refinance and perhaps acquire more property.

2. Trade from non-productive land for improved property that can generate cash flow.

3. Trade from a high appreciation property, such as a house or apartment, for a high
cash flow property, such a retail store. This can be used to create cash flow for
retirement.

4. Exchange from a property with a high debt service for a property with lower payments
and lower interest rates.

5. Exchange to change the lifestyle of a client. For example, exchange for a property
requiring reduced management effort for the retiree who desires to travel.

6. Trade from multiple properties into one larger property, or trade one property for multiple properties depending on the desires of the client.

Properties that qualify for an exchange under Section 1031 can be confusing at times. Any questions can be answered by referring to the Code. The code allows room for flexibility and several options are available to create many exchange opportunities. Any investment property should be an automatic candidate for an exchange. An exchange facilitator can simplify the procedure.

Contact us (Click Here) for a What-If analysis if you should sell or exchange.