A 1031 exchange, more commonly known as a “like-kind” exchange, is a legal tool that allows real estate owners to exchange pieces of property and defer capital gains taxes. This generally applies to investment or business properties. In the past, there was the ability to extend this tool to personal property. The Internal Revenue Service (IRS) cracked down on this practice with the Tax Cuts and Jobs Act. As a result, like-kind exchanges are best suited for business or investment properties. Examples can include an exchange of an office building for another office building or potentially even an apartment complex or vacant land.
Are there any changes to like-kind exchanges this year?
The pandemic did have some impact on the application of this tax benefit. This impacted the timeline that helps guide these exchanges. The IRS realized the impact of the pandemic on real estate deals and provided an extension on the deadlines for 2020. Unfortunately, the IRS did not extend these deadlines any further.
Those who have used 1031 exchanges in the past are wise to review the changes noted above. It is now unlikely that a property owner can use this tax savings technique on personal property. One potential loophole is to convert the property to a rental unit. It is possible for long-term planning to use the property as a rental unit, use the 1031 to buy another rental property and later convert that new rental property to a primary residence.
It is important to point out that these are long-term plans — years not months — and require careful consideration to make sure they are in line with applicable tax law.
Is there anything else I should know about 1031 exchanges before moving forward with these plans?
Property owners can further ensure a smooth transition by having the real estate documents drafted to their specific transaction. This mitigates the risk of any surprises that can come with boilerplate, fill-in-the-blank documents that are not drafted specifically for your real estate deal.