Like Kind Exchanges Under Section 1031
The “like kind exchange” or “1031 exchange” is a non-recognition rule embodied in Section 1031(a)(1) of the Internal Revenue Code. That section states, in part, that no gain or loss is recognized when property held for productive use in a trade, a business or for an investment purpose is exchanged solely for property of like kind to be held for productive use in a trade, a business or for investment. http://www.forbes.com/2010/01/26/capital-gains-tax-1031-vacation-home-personal-finance-robert-wood.html
In plain English, the 1031 exchange rules allow a person to swap a piece of land being used in a business for another “similar” piece of land to be used in a business. There is no gain or loss recognized because of the transaction; therefore no taxes are owed when the transaction is complete. The 1031 exchange rules as they apply to real property are incredibly broad. A person taking part in a 1031 exchange may swap a piece of land holding a strip mall for a piece of land being used to grow cotton. As long as the land continues to be used in a “trade or business” and the other requirements of 1031 are met, there will be no recognition of gain or loss on the transaction.
There are a few limitations. As stated above, both pieces of real property in the exchange must be held for productive use in a trade or business or for investment. Thus, a person wanting to exchange a piece of residential real estate held as rental property for a piece of residential real estate to be used as the person’s home would not qualify for a 1031 exchange. Second, any property received in a 1031 exchange must be held for at least two years after the exchange. If either of these holding requirements is not met, the gain or loss that was not recognized on the initial transfer must be reported to the IRS in the year the transfer occurs.
Section 1031 like kind exchanges are a complicated yet highly effective method of acquiring real property and are especially relevant to the farmers and ranchers of the South Plains. If done properly, a 1031 exchange can be an excellent tax savings device. The attorneys at the McCleskey law firm are experienced in 1031 exchanges and are available to answer questions you may have regarding this issue.