Under the Tax Cuts and Jobs Act, Section 1031 now applies only to exchanges of real property and not to exchanges of personal or intangible property. An exchange of real property held primarily for sale still does not qualify as a like-kind exchange. Financial and investment advisers should seek to understand the implications of a legislative proposal originally set forth in the American Families Plan that would severely limit benefits historically provided by Sec. 1031 of the Internal Revenue Code. Under the proposal, the deferral of capital gains from the exchange of real property used in a trade or business, or of investment property, would be limited to $500,000 ($1 million for married individuals filing jointly). At the time of this writing, Congress is actively considering major tax legislation that may include such a limitation on Sec. 1031 exchanges.

Special Considerations for Real Estate Investments

All 1031 exchanges must use a Qualified Intermediary (QI) to hold the exchange funds. Real estate investments often make up the bulk of 1031 Exchanges due to the flexibility journal entry for 1031 exchange in determining what constitutes “like-kind” property. Therefore, thorough understanding and precise execution of these rules are essential in a 1031 Exchange transaction.

Exchange Rules FAQs

• Gains are not recorded on exchanges lacking commercial substance and are typically illustrated in more advanced courses.
• The Treasury and IRS released final regulations (TD 9935) (Final Regulations) defining real property for the purpose of like-kind exchanges under IRC Section 1031.
• Successful execution of a 1031 exchange is a valuable tool investors can use to increase the leverage of their investments.
• Appliances, inventory, and other PP&E do not count as valid replacement assets in a 1031 Exchange.

However, Sec. 1031 may not be a viable option for high-income taxpayers in the future, given the current political climate. Successful completion of a like-kind exchange is an extremely rules-based endeavor, which, in most cases, will require the assistance of both a CPA and an independent intermediary to achieve the desired outcome. According to the National Association of Realtors, median home prices in September 2021 were up 13.3% compared with the same time a year earlier (NAR, Summary of September 2021 Existing Home Sales Statistics). Meanwhile, interest rates on 30-year fixed-rate mortgages have remained flat at an attractive rate of just above 3% on average. Investors who have experienced appreciation in the current strong real estate market might consider selling their property while housing prices are at market highs, which for many would mean recognizing capital gains.

What should I do if I’ve made a mistake in my previous 1031 Exchange reporting?

This timeline runs concurrently with the 45-day identification period. This means that the investor does not have an additional 180 days post the 45-day identification period. A Simultaneous 1031 Exchange happens when the relinquished and replacement properties are closed on the same day. If done correctly, a 1031 exchange can be a powerful tool for building wealth through real estate investment. Consider an investor who owns an apartment building valued at $1 million. The investor has held this rental property for several years and has accumulated substantial appreciation, making the building worth more now than when they initially purchased it.

What is the approximate value of your cash savings and other investments?

When you eventually sell the replacement property (unless you do another 1031 Exchange), you’ll pay the deferred capital gains tax. Certain fixed assets, such as machinery or equipment, often accompany real property and must be analyzed to determine whether they are part of the real property. Likewise, some structural components may be personal property rather than real property for the same reason. Taxpayers may perform a functional test for structural components to determine whether they serve an inherently permanent structure. For example, the preamble states, a natural gas line to a furnace may be real property, but a similar gas line to a fryer and ovens is not.

Get in Touch With a Financial Advisor

Alternative investments are often sold by prospectus that discloses all risks, fees, and expenses. They are not tax efficient and an investor should consult with his/her tax advisor prior to investing. The value of the investment may fall as well as rise and investors may get back less than they invested. Aside from deferring capital gains tax, you may be exempt from paying state mandatory withholding. The Tax Cuts and Jobs Act made some changes to the Section 1031 exchange rules. Personal property and intangible property will no longer qualify for a like-kind exchange.

Your exchange (even though it spans different tax years) needs to be reported on your 2021 return Form 8824 (even if the exchange was completed in 2022). If you file a return without the exchange complete, that triggers your cap gains/depreciation recapture and you lose the exchange. ‘Boot’ refers to any cash or non-like-kind property received in a 1031 Exchange. It’s often received when the properties exchanged are not of equal value, and cash is added to balance the transaction. The ‘Boot’ is considered taxable and must be reported as part of your 1031 Exchange on IRS Form 8824.

You can leverage it to sell an investment property and reinvest the proceeds in a new one, effectively postponing the tax liability. Like-kind exchanges — when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or “like-kind” — have long been permitted under the Internal Revenue Code. Generally, if you make a like-kind exchange, you are not required to recognize a gain or loss under Internal Revenue Code Section 1031.

Get Forbes Advisor’s ratings of the best mortgage lenders, advice on where to find the lowest mortgage or refinance rates, and other tips for buying and selling real estate. Real properties generally are of like-kind, regardless of whether they’re improved or unimproved. For example, an apartment building would generally be like-kind to another apartment building. However, real property in the United States is not like-kind to real property outside the United States. Another prevalent mistake is the incorrect reporting of gains from a 1031 exchange. Accurate calculation of the gain is vital to avoid substantial tax penalties.