The first major requirement for a 1031 exchange is that the properties involved in the exchange (both the relinquished property that you’re giving up and the new replacement property that you’ll receive) have to be held for a “qualifying purpose.” That means that the properties have to be held in use for one of the following purposes:
- For use in your trade or business
- For investment purposes
To explain what trade means in this instance, let’s use the classic example of a blacksmith. Blacksmithing is a blacksmith’s trade. Imagine the blacksmith has a blacksmithing shop where he does business. The blacksmith can do a 1031 exchange on the land and building he uses for his business because it is being held for a qualifying purpose (in other words he is operating his business there).
Another (perhaps more modern) example is a person who owns an apartment and operates a rental business out of their apartment buildings.
The other way to qualify for a 1031 exchange is if the properties are used for investment purposes. Consider a real estate speculator who buys a piece of raw land hoping the land will appreciate in the future. In this case, the investor can use that land for a 1031 exchange because they have held it for investment purposes.
What is Like-Kind Property?
In order to meet the requirements for a 1031, the properties involved must also be “like-kind” properties. Like-kind properties fall into 2 basic categories:
- Real properties. Raw land can be exchanged for improved land (with buildings). As long as it is considered real property, the differences in grade or quality do not matter. Real properties can include residential, commercial and industrial real estate. There is great latitude and flexibility when it comes to exchanging real properties in the U.S.
- Personal properties. These can include aircraft, collector cars, artwork, taxi-cab medallions, agricultural and business equipment, etc. There are tighter restrictions on the like-kind requirements for personal property 1031 exchanges. For example, a heavy-duty truck could not be exchanged for an expensive painting or a boat, because the properties are not of like-kind.
Learn more about like-kind property by watching the video below:
A Note about Foreign Property
A real property in the United States and a real property in another country are not “like-kind” properties. Similarly, a personal property that is used primarily inside the US, and a personal property used primarily outside the country are not “like-kind.”
Benefits of a 1031 Exchange
So what is the benefit of a 1031 exchange? From our government’s perspective, Section 1031 exists to stimulate our nation’s economic growth and avoid stagnation by encouraging people to dispose of lesser or under-producing assets and to acquire new like-kind properties that will (ideally) be better utilized in our economy. This encourages entrepreneurs to take chances on more advantageous investments. This velocity of selling and buying creates jobs for all of the people involved, such as real estate agents, attorneys, title companies, tax assessors, and other professionals.
The same thing goes for doing a 1031 exchange on business equipment that has some value over and above its current basis of book value (adjusted down from deprecation). If you have old, worn out business equipment which still retains some value, that you want to dispose of, you can either sell it (in a taxable transaction), or 1031 exchange out of it and into better, more efficient equipment to increase productivity.
Twin Cities 1031 Exchange Services
Some of the best types of personal property for 1031 exchanges are property with a long maker’s life, such as railroad cars, aircraft, cranes or bulldozers. These types of properties will often have significant residual value even after they have been depreciated down to zero (book value). Also, collector cars, numismatic coins, and artwork held for investment may appreciate tremendously in value over its initial cost. Anytime there is a large gain, a 1031 exchange is an attractive option to consider.
Contact us today at our downtown Minneapolis office to discuss whether your property is eligible for a 1031 exchange 612.643.1031.