1031 Exchange Lawyers — LaGrange, IL.

Serving Hinsdale, Western Springs, Westchester, Brookfield & The Chicagoland Area

Exchanging Real Property -- Investment Real Estate

Section 1031 of the Internal Revenue Code (26 U.S.C. § 1031) is designed to help real estate investors, or any commercial property owners, to shift their focus on their trade without incurring the tax liability. A Section 1031 Exchange, also known as a "like kind exchange" or a "Starker exchange", is a tax-deferment strategy that allows a property owner to defer paying capital gains taxes on real property when it is sold, as long as the profit from this sale is used to purchase another "like kind property." Investors can trade properties with no obligation to pay taxes on the sale until the investor cashes out and realizes the capital gain. This tax benefit currently translates into immediate cash savings of to 20% of the value of the property.

What Qualifies for a "Like Kind" Exchange?

Previously, section 1031 applied to a wide array of property. The Tax Cuts and Jobs Act of 2017, however, amended the rule to apply to real property only. Thus, effective January 1, 2018, the exchanges of personal or tangible property, such as machinery, equipment, intellectual property, or security instruments, are not eligible for tax deferment under this section.

“Like Kind” Property & Benefits

The statute specifies that the property to be exchanged must be of "like kind", and to be held either for "either for productive use in a trade or business or as an investment". (26 U.S.C. § 1031(1)) Most real estate properties located within the United States are considered to be "like kind", whether improved or unimproved (land). Note, however, that both the original and the replacement property must be located within the United States, a foreign real estate does not qualify as a like kind exchange under this section.

Exchanges can include more than 2 properties. For example, an owner may exchange multiple properties for one bigger property.  The property to be exchanged must be held for investment or business use. A real estate held as an inventory or purely for a resale purpose does not qualify for capital gains tax deferment under this rule. If the purchase and sale of real property is conducted in the ordinary course of business, any loss or gain from those sales is considered ordinary income, not capital gain.

Another exception to this rule is transactions involving primary residence. Unfortunately, you can't swap one primary residence for another and defer capital gains tax under this rule. Examples are:

  • An individual who moved from Illinois to Florida could not exchange her primary residence in Illinois for another primary residence in Florida.
  • An individual who gets married and moves into her spouse's home, could not exchange her former primary residence for a vacation home.
  • A single-family rental property in LaGrange may be exchanged for a commercial rental property in Chicago.
  • A rental property in Wisconsin could not be exchanged for a rental property in Mexico, in spite of the geographical proximity.
  • A building used for commercial purposes in Westchester may be exchanged for two single-family rental homes in LaGrange.

What are the Types of Exchanges?

There are four main types of like kind exchanges: simultaneous, delayed, reverse, and construction. The most common type is the delayed exchange. This type of exchange involves 3 parties and gives the seller some flexibility in finding the right property to purchase. It occurs when the seller relinquishes the original property before she acquires replacement property. In order to begin this transaction, the seller must hire a Qualified Exchange Intermediary (middleman) that will initiate the sale of the property and hold the proceeds from this sale in a binding trust for up to 180 days while the seller acquires another property. A business lawyer may act as your Exchange Intermediary.

To learn more about 1031 Exchanges and if they are a right fit for you, then please schedule an appointment with Fornaro Law today!