Exchange Requirements

The following requirements must be met to effectuate a tax-free exchange:

1. 1. Exchange must involve qualified property, either real or personal.  Qualified property is property that is either held for investment or for use in a trade or business.  Qualified property does not include real property used exclusively as a principal residence or vacation home.Additionally, 1031 exchange does not apply to the following types of property:
      • stock in trade or other property held primarily for sale;
      • stocks, bonds, or notes;
      • other securities or evidences of indebtedness or interest;
      • interests in a partnership;
      • certificates of trust or beneficial interests; or
      • choses in action.
   2. Property sold must be “like-kind” to property purchased.  The like-kind requirement for real property is very broad.  Generally, all real property is like-kind to all other real property.  For example, vacant land held for investment is like-kind to improved commercial or residential property.  Therefore, a residential investment property can be exchanged for a commercial investment property or for vacant land held for investment.  Other examples of real property that can be exchanged are perpetual water rights (if considered real property under state law),  easements, tenants-in-common interests, and leasehold interest with 30 years or more to run (including all unexercised option periods).
   3. To fully defer all capital gains taxes, an Investor must meet two basic requirements:
      1. Reinvest all Exchange Equity. All equity received from the sale of the Relinquished Property (sales price less debt payoff and exchange expenses) must be utilized as a down payment on the Replacement Property. Any cash received by the Investor and not reinvested into Replacement Property will be considered “cash boot” and subject to tax.
      2. Acquire Property of Equal or Greater Value. If an Investor does not acquire Replacement Property whose purchase price is not equal or greater than the net sales price of the Relinquished Property (i.e. sales price less Exchange Expenses), the trade down in value will be considered “boot” and may be subject to tax.

Click here to see an example of a tax-free exchange

1. Replacement Property must be acquired by the same taxpayer that sold the Relinquished Property. For example:
   

   If

   • Husband sells Relinquished Property, then Husband must acquire the Replacement Property.
   • If a Limited Liability Company, Partnership, Trust or Corporation sells, then same Limited Liability Company, Partnership, Trust or Corporation must acquire.

   Due to many lender requirements, it is important to anticipate vesting issues prior to initiating the exchange. Through use of disregarded entities like single member limited liability companies, there are alternative vesting options provided that these options are planned for and negotiated prior to the exchange.

2. Sale must be set up as an exchange PRIOR to closing on the Relinquished Property  See Steps to Initiate and Exchange.