1. The Relinquished Property Must Be Qualifying Property
Qualifying property is property (or equipment) held for investment purposes or used in a taxpayer's trade or business. Investment property includes real estate, improved or unimproved, held for investment or income producing purposes. Property used in a taxpayer's trade or business includes is office facilities or place of doing business, as well as equipment used in his trade or business. Real estate must be replaced with like-kind real state. Equipment must be replaced with like-kind equipment.
2. Property Which Does Not Qualify for a 1031 Exchange includes —
3. Replacement Property Title Must Be Taken in the Same Name as the Relinquished Property Was Titled
If a husband and wife own property in joint tenancy or as tenants in common, the Replacement Property must be deeded to both spouses, either as joint tenants or as tenants in common. Corporations, partnerships, limited liability companies and trusts must be in title on the Replacement Property the same as they were on the Relinquished Property.
4. The Replacement Property Must Be Like Kind
For real estate exchanges, like-kind Replacement Property means any improved or unimproved real estate held for income, investment or business use. For instance –
As referenced above, a taxpayer's personal residence cannot be exchanged for income property and income or investment property cannot be exchanged for a personal residence which the taxpayer will reside in. See an expanded explanation below of different kinds of real estate interests which are like kind for real estate exchanges.
5. Any Boot Received in Addition to Like-kind Replacement Property Will Be Taxable (to the extent of gain realized on the exchange)
This is okay when a seller desires some cash or debt reduction and is willing to pay some taxes. Otherwise, boot should be avoided in order for a 1031 Exchange to be completely tax free.
The term "boot" is not used in the Internal Revenue Code or the Regulations but is commonly used in discussing the tax consequences of a Section 1031 tax-deferred exchange. Boot received is the money, debt relief or the fair market value of "other property" received by the taxpayer in an exchange. Money includes all cash equivalents received by the taxpayer. Debt relief is any net debt reduction which occurs as a result of the exchange taking into account the debt on the Relinquished Property and the Replacement Property. "Other property" is property that is non-like-kind, such as personal property received in an exchange of real property, property used for personal purposes, or "non-qualified property." "Other property" also includes such things as a promissory note received from a buyer (Seller Financing).
A Rule Of Thumb for avoiding "boot" is to always replace with property of equal or greater value than the Relinquished Property. Never "trade down." Trading down always results in boot received, either cash, debt reduction or both. Boot received is mitigated by exchange expenses paid. See The Rules Of Boot In A Section 1031 Exchange (below) for a detailed explanation of these rules.
Real Estate Interests Which Qualify as Like-Kind for a 1031 Exchange
The following types of real estate interests are deemed by Congress and the IRS to qualify as like-kind to each other for a 1031 Exchange —
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