Internal Revenue Code section 1031
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Under Section 1031 of the Internal Revenue Code (), the exchange of certain types of property may defer the recognition of capital gains or losses due upon sale, and hence defer any capital gains taxes otherwise due.
To qualify for Section 1031 of the Internal Revenue Code, the properties exchanged must be held for productive use in a trade or business or for investment. Stocks, bonds, and other properties are listed as expressly excluded by Section 1031 of the Internal Revenue Code. The properties exchanged must be "like-kind", i.e. of the same nature or character, even if they differ in grade or quality. Personal properties of a like class are like-kind properties. Personal property used predominantly in the United States and personal property used predominantly elsewhere are not like-kind properties.
Real properties generally are of like-kind, regardless of whether the properties are improved or unimproved. However, real property in the United States and real property outside the United States are not like-kind properties.
Taxpayers may wonder whether items such as equipment used on a property are included in the lump-sum sale of the property, and if they are able to be deferred. Under treasury regulation §1.1031(k)-1(c)(5)(i), property that is transferred together with the larger item of value will not exceed 15% of the fair market value of the larger property. So for equipment with a fair market value of $15,000, as long as the qualified like-kind property sells for >$100,000, the equipment can be included in the exchange of property and any gain realized can be deferred.
Cash to equalize a transaction cannot be deferred under Code Section 1031 because it is not like-kind. This cash is called "boot" and is taxed at a normal capital gains rate.
If liabilities assumed by the buyer exceed those of the seller (taxpayer), the realized gain of the seller will be not only realized, but recognized as well. If however, the seller assumes a greater liability than the buyer the realized loss cannot offset any realized and recognized gain of receiving boot such as cash or other personal property considered boot.
Originally, 1031 cases needed to be simultaneous transfers of ownership. But since Starker vs. U.S. (602 F.2d 1341), a contract to exchange properties in the future is practically the same as a simultaneous transfer. It is under this case that the rules for election of a delayed 1031 originated. To elect the 1031 recognition, a taxpayer must identify the property for exchange before closing, identify the replace property within 45 days of closing, and acquire the replacement property within 180 days of closing. A Qualified Intermediary must also be used to facilitate the transaction.
Section 1031 Like-Kind Exchanges
Section 1031(a) of the Internal Revenue Code () states the
recognition rules for realized gains (or losses) that arise as a result of an exchange of like-kind property held for productive
use in trade or business or for investment. It states that none of the realized gain or loss will be recognized. It also states
that losses cannot be deducted.
1031(b) states when like-kind property and boot can be received. The gain is recognized to the extent of boot received.
1031(c) covers cases similar to those in 1031(b) except when the transaction results in a loss. The loss is not recognized at the time of the transaction, but must be carried forward in the form of a higher basis on the property received.
1031(d) defines the basis calculation for property acquired during a like-kind exchange. It states that the basis of the new property is the same as the basis of the property given up, minus any money received by the taxpayer, plus any gain (or minus any loss) recognized on the transaction. If the transaction falls under 1031(b) or (c), the basis shall be allocated between the properties received (other than money) and for purposes of allocation, there shall be assigned to such other property an amount equivalent to its Fair Market Value at the date of the exchange.
1031(e) stipulates that livestock of different sexes do not qualify for like kind exchange.
1031(h)(1) stipulates that real property outside the United States and real property located in the United States are not of like kind.
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