What Does Not Qualify for a 1031 Exchange?

If our 1031 Exchange Series has you gearing up to sell your Commercial Real Estate (CRE) property, be sure to read the fine print – the Internal Revenue Service (IRS) imposes a slew of restrictions on what types of properties can participate.

To refresh your memory, we’ll remind you that a 1031 exchange (a.k.a. the like-kind exchange) is utilized by owners of investment or business property. The exchange allows investors to defer capital gain taxes if they sell a property and swap it with another of the same kind, meaning they carry the “same nature, character or class,” according to the IRS.

 

Did you know? Property in the U.S. is not like-kind to property that falls outside its border.

All properties involved in a 1031 exchange must be held for business or investment use. Both real and personal property qualifies for the exchange, but personal property exchanges can be more restrictive. According to the IRS, four categories of property are completely excluded from the exchange and they’re explained below:

Inventory or Stock in Trade:
According to Equity Advantage, the IRS draws a line between investors who hold commercial properties for longer than a year and those who purchase properties with the intent of making improvements quickly and selling. They’re called “dealer properties” and they’re barred from participating in the the exchange because the property is considered inventory. Equity advantage calls it the “one of the largest ‘gray areas’ of Section 1031.”

Stock, Bonds or Notes and Other Securities or Debt:
Despite the fact that stocks and other non-real estate assets can be traded in corporate reorganization under Section 1036 (a) and Section 1037, the 1031 exchange allows just the opposite, explains Asset Preservation Inc. Even if these items are secured by a commercial property, they’re always excluded from 1031 exchange.

Partnership Interests:
Excluding an interest in a partnership was penned into the Internal Revenue Code in 1984, according to Asset Preservation Inc. By law, a limited liability company, also called a partnership, cannot participate in the 1031 exchange if an individual partner has no interest in the capital asset owned by the partnership. “The fact that a partnership owns a capital asset does not mean that the individual partners have an ownership interest in that asset,” says Asset Preservation Inc.

Certificates of Trust:
According to Asset Preservation Inc, these documents only represent a right to an interest in stock or a corporation and do not reflect a stake in real property. For that reason, they’re excluded from the exchange.

For more readings visit: IRS,  Asset Preservation Inc., and Equity Advantage.

 

Want to learn more about 1031 Exchanges? Stay tuned, we’ll be blogging more about 1031 Exchanges in the days to come.

Read all the articles in our 1031 Exchange series here: https://www.mynoi.com/category/1031-exchange/

Stefanie Donahue is a freelance writer based in Bellingham, Washington. She’s a well-versed communicator with an extensive background in journalism and media production. Her writing draws from the insight of industry experts to uncover best practices for real estate investors.