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Section 1031 Like-Kind Exchanges Serve as Vital Stimulant for Economic Growth

Date: April 1, 2013

After several years, real estate values are beginning to recover and activity is steadily increasing. It's a promising trend that needs to be supported, not thwarted. IRC Section 1031 like-kind exchanges are one of the best ways to support it. Improving conditions in the real estate market could be reversed if tax reform efforts in Washington D.C. impact taxpayer's ability to utilize Section 1031, according to David Brown, President of the Federation of Exchange Accommodators (FEA), a national trade organization for professionals specializing in the field.

Property values in the commercial real estate sector are not rebounding as quickly as the general housing market. Investors, lawmakers, REALTORS® and other real estate professionals continue to search for ways to encourage investment in commercial property and increase transaction volume. Like-kind exchanges under IRC Section 1031 definitely help - eliminating them would certainly hurt.

The use of a Section 1031 like-kind exchange has historically been the vehicle that has ensured continued investment in commercial, agricultural and rental real estate. Section 1031 is also substantially used by businesses to exchange non-real estate assets, including trucks, trailers, containers, railcars, airplanes, agricultural equipment, other heavy equipment, livestock and other assets. A Section 1031 exchange allows investors to upgrade and expand their facilities and equipment, redeploy assets to other geographical areas, and capitalize on new labor pools. At the same time, a Section 1031 exchange requires that the proceeds received from the sale of domestic real estate be reinvested within 180 days in property within the United States - thereby serving as a critical stimulus to the real estate market and a vehicle to keep investment dollars on our shores.

Repealing or restricting IRC Section 1031, in the guise of tax reform, has the potential to quash the nascent real estate recovery. The House Ways and Means Committee has established eleven working groups that are exploring various tax reform initiatives - including a possible repeal or modification of Section 1031. Considering the maximum federal capital gains tax rate was raised by two-thirds this year, and upon factoring in state taxes, repeal of or substantial changes to Section 1031 could force property owners to hold properties versus sell, perhaps contributing to further erosion of market conditions.

“Like-kind exchanges stimulate economic growth,” according to Brown. “Repealing or curbing the applicability of Section 1031 would critically injure businesses, investors and the real estate market which is just now showing signs of getting back on its feet.” Brown is quick to point out that Section 1031 is not a tax dodge. Section 1031 allows investors to generate additional equity so long as the investment stays in place. Capital gains taxes become due whenever taxpayers don't use all of the funds received from a sale or ultimately "cash out" of their property.

Tax reform efforts are underway in both the House and the Senate. While Congress is not expected to enact reform legislation in the immediate future, decisions made in the coming weeks and months on issues, such as Section 1031, will be extremely difficult to reverse in the endgame of reform legislation. The Federation of Exchange Accommodators (FEA) has worked diligently to educate Members of Congress and other policymakers on the importance of Section 1031. These efforts could be undone, however, as higher profile issues consume the attention of the House and Senate tax-writing committees.

The FEA is concerned that as tax reform discussions and drafting of legislation progress, Section 1031 property exchanges may be a target due to its score as a "tax expenditure." The benefits to the economy of tax deferred exchanges of property, including commercial/industrial property, far outweigh the perceived loss of tax revenue. Section 1031 exchanges are a proven benefit to investors in the commercial/industrial property sector and incentivize investment in US property. This, in turn invigorates the economy at large.

The House Ways and Means Committee has established an April 15 deadline for comments on a range of tax reform proposals. The email address for submitting comments is

Media Contact

David Brown
President, FEA
(515) 279-1111

David Franasiak
Williams & Jensen
(202) 659-8201

About the FEA

The Federation of Exchange Accommodators is the industry association for professional exchange facilitators, also known as QIs. FEA member companies facilitate tax-deferred exchanges of investment and business use properties under Section 1031 of the Internal Revenue Code for taxpayers of all sizes, from individuals of modest means to high net worth taxpayers and from small businesses to large entities. Members represent a broad spectrum of the industry, ranging from small, privately held businesses to large, publicly traded companies and banks, located in small towns to large cities across the nation.

Federation of Exchange Accommodators Praises Passage of New Exchange Facilitator Regulations in Colorado

Date: March 25, 2009

Rep. Joel Judd applauded for defending the interests of consumers and businesses performing Section 1031 exchanges
" client should have reason to fear doing a Like Kind-Exchange."

(Denver) Colorado House Bill 09-1254, sponsored by State Representative Joel Judd and State Senator Ted Harvey, has been unanimously passed by the 67th General Assembly of the State of Colorado. This legislation is designed to create consumer protections relating to Section 1031 Like-Kind Exchanges facilitated by Qualified Intermediaries (QI) and Exchange Accommodation Titleholders, otherwise known as Exchange Facilitators.

For the past two years a group of QIs committed to responsible business practice has served as a resource team for legislators promoting this bill. The team, comprised of members of the Federation of Exchange Accommodators (FEA), included committee leader Brent Abrahm of Accruit, Mary Lou Schwab of Bankers Escrow; Paul Holloway of Land Title Exchange Corporation; David Wright of 1031 Corporation Exchange Professionals; Scott Saunders of Asset Preservation; Suzanne Goldstein Baker of Investment Property Exchange Services, Inc. (IPX1031); and Max Hansen of American Equity Exchange, Inc. Abrahm, Baker, and Hansen also serve on the FEA's Board of Directors.

Abrahm, CEO of Denver-based Accruit, LLC, explains that "the like-kind exchange (LKE) was added to the Internal Revenue Code in 1921 to promote business reinvestment in our economy. It is important, especially during difficult economic times like the present, that this ultimate stimulus tool be governed in the best interests of the consumers and businesses that utilize it. We applaud Representative Judd and Senator Harvey for supporting legislation that protects the integrity of the services provided by QIs doing business in Colorado. It's been an honor to be a resource for this landmark legislation, which will ensure appropriate business standards for all QIs in the state."

Jason Hopfer of JLH Public Affairs said, "It's a pleasure to assist these industry leaders, through the FEA, in their quest to protect and preserve this tax planning tool and the businesses in Colorado that it serves."

The FEA, which represents Qualified Intermediaries nationwide, requires that its members follow a strict code of ethics consistent with the legislation presented by Representative Judd. Billions of dollars in like-kind exchanges for real estate and other business assets are transacted each year, and House Bill 09-1254 will ensure that all Colorado Exchange Facilitators follow secure banking procedures that provide sufficient liquidity of funds to meet their obligations to their clients.

"The FEA Code of Ethics very specifically provides every member organization a set of standards and business processes to safely handle assets and business funds" says Hugh Pollard, President of the FEA. "With proper due diligence, no client should have reason to fear doing an LKE. Each client should ask detailed and specific questions about how their money will be invested and they should make sure that their QI provides proper financial assurances."


The Federation of Exchange Accommodators (FEA) is the only national trade organization formed to represent qualified intermediaries (QIs), their primary legal/tax advisors and affiliates who are directly involved in Section 1031 Exchanges. Formed in 1989, the FEA was organized to promote the discussion of ideas and innovations in the industry, to establish and promote ethical standards of conduct for QIs, to offer education to both the exchange industry and the general public, and to work toward the development of uniformity of practice and terminology within the exchange profession. The FEA also provides timely input and updates on pending State and Federal legislation, Internal Revenue Service and Treasury Rulings, and Court Decisions. Parties with questions about Section 1031 and its operating principles are encouraged to contact the FEA at 215.564.3484 or visit the Web site at

Housing Assistance Tax Act of 2008 Reduces Benefits of a Tax-Free Personal Residence Sale

Date: August 5, 2008

The Housing Assistance Tax Act of 2008 signed by President Bush on July 30, 2008 contains sweeping measures to shore up the ailing housing market. It tightens lending practices and reform financial institutions associated with that market. It also includes a 96-page tax title that carries tax breaks for home buyers and homeowners. Included is a modification to the Section121 exclusion of gain on the sale of a primary residence.

Under Code Section 121 a taxpayer can exclude up to $250,000 ($500,000 for married couples filing jointly) of gain realized on the sale of a principal (primary) residence. In order to be eligible for the Code Section 121 exclusion, the residence must have been owned and occupied as the taxpayer's primary residence for periods of time adding up to two years within the preceding five year period. However, any  depreciation taken on the property since May 1997 is not excluded.

Taxpayers often have more than one residence. A second residence which is not the taxpayer's primary residence for the required two years is not eligible for the §121 exclusion. The 2008 Housing Act deals with situations where the taxpayer is selling a residence which has not always been the taxpayer's primary residence. For instance –

  • The taxpayer moves into a second residence and after residing in it for two years, sells it, or
  • The taxpayer moves into a residence which he has previously owned as a rental property and after residing in it for two years, sells it, or
  • The taxpayer sells a residence in which he has lived in, for two years during the preceding five years, but is not currently residing in it. Perhaps he has converted it to a second residence or a rental property.

Effective January 1, 2009 any periods of time in which the residence is not the taxpayer’s primary residence is defined as "nonqualified use."  If the taxpayer subsequently converts the residence to his primary residence, lives in it for two years and then sells it, a portion of the gain is not eligible for the §121 exclusion.

For instance, taxpayer purchases a residence on January 1, 2007 for use as a second home or rental property.  On January 1, 2010 taxpayer converts the residence to his primary residence.  After living in the residence for two years taxpayer sells it on January 1, 2012.  The taxpayer has owned the residence for five years.  The residence was used for  “nonqualified use” for one year from January 1, 2009 to January 1, 2010.  Under the new rules the gain eligible for the §121 exclusion must be prorated as follows -

  • One fifth (1/5 years) of the gain would not be eligible for the $250,000 exclusion.
  • Four fifths (4/5 years) of the gain would be eligible for the exclusion.

Nonqualified use, as defined under the Act, does not apply to periods of time after the taxpayer has discontinued use of the residence of his primary residence and then subsequently sells the residence. 

Potential 1031 Exchange Issues

Taxpayers frequently exchange an investment property for a qualifying investment replacement property with the intent to convert it to a personal residence after one or two years. The game plan has previously been to eventually qualify the residence under Code Section 121 for a tax-free gain on the sale of the property (again, except for depreciation taken on the property since May, 1997).

When it goes into effect, this new law will impact this tax strategy. Any nonqualified use of the property after January 1, 2009 will be subject to the new law that limits the application of the §121 gain exclusion. This will require careful consideration by taxpayers, and their tax professionals, to determine the best tax strategy on the sale of a previous investment property that is now their primary residence.

Taxpayer May Acquire Replacement Property From a Related Party If the Related Party Is Also Doing an Exchange

Executive Summary - Taxpayers cannot acquire Replacement Property from a related party in a three-party exchange if the related party is "cashing-out." Rev. Rul. 2002-83 says that acquiring Replacement Property from a related party who is cashing-out in a three-party exchange doesn't qualify for non-recognition under IRC §1031. But if the related party is also doing an exchange (not cashing-out) it is okay.

Explanation - An exchange between related persons generally qualifies for non-recognition treatment under IRC §1031 if the property or properties which are exchanged are held for two-years or more by the related parties. A disposition of any kind within two years by either of the related parties causes the deferred income to become taxable in the year of the disposition. This is referred to as the "two-year rule." Related parties as a definition include members of a taxpayer's family and also include transactions between a taxpayer and his corporation, partnership or LLC if the taxpayer or members of his family own more than 50% of the entity.

In Practice, few exchanges occur directly between related parties where each deeds to the other and where an exchange is entirely between related parties (a deed-swap) with no participation by an unrelated third party. However, related-party issues can arise in a three-party exchange when a related party either receives deed to the relinquished party or when the taxpayer receives deed to a replacement property from a related-party, even though an unrelated third-party is otherwise a participant in the exchange.

Purchase of Replacement Property from a Related Party is disallowed (Rev. Rul. 2002-83) if the related party is "cashing out." The IRS reasons that if the taxpayer or a related party "cashes out" of property in this manner, IRC §131(f)(4) "kicks-in" and the exchange is disallowed. But, if the related party is also doing an exchange (not cashing out) recently issued PLRs 200440002 and 200616005 say it is ok.

Sale to a related party, replacement from an unrelated party. A taxpayer will often sell to a related party but receive replacement property from an unrelated party. This is OK but it has been unclear whether the related party was required to hold the property it acquired from the taxpayer for two years. Instructions to Form 8824 seem to imply that the two-year rule applies. Tax and exchange professionals have generally advised their clients to comply with the two-year rule. However, PLR 200706001, PLR 200712013 and PLR 200728008 released in 2007 say that the two-year rule does not apply to a related party who purchased the relinquished property from the taxpayer.

Safe Harbor for Exchanges of Vacation Homes and Conversions to or from Personal Residences

Revenue Procedure 2008-16 (pdf) provides a safe harbor under which the IRS will not challenge whether a dwelling unit qualifies as property held for productive use in a trade or business or for investment under Section 1031. This revenue procedure follows Moore v. Commissioner, T.C. Memo. 2007-134 (the recent vacation home case) and the Treasury Inspector General for Tax Administration (TIGTA) report "Like-Kind Exchanges Require Oversight to Ensure Taxpayer Compliance" (9/17/07), which called for more IRS guidance on vacation home exchanges. The safe harbor, while specifically addressing the vacation home issue, also indirectly addresses the issue of converting a principal residence into qualifying relinquished property prior to an exchange, or converting a replacement property into a personal residence after an exchange.

It is just a safe harbor. An exchange may still fall outside the parameters and meet the statutory requirements, but you should expect heightened scrutiny in such a case. The safe harbor is effective for exchanges occurring on or after March 10, 2008.

Relinquished Property. A dwelling unit qualifies as relinquished property in an exchange if it is owned by the taxpayer for at least 24 months immediately before the exchange, and, in each of the two 12-month periods immediately preceding the start of the exchange: (i) The taxpayer rents the relinquished property to another person at a fair rental for 14 days or more, and (ii) the taxpayer's personal use of the relinquished property does not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the relinquished property is rented at a fair rental.

Replacement Property. A dwelling unit qualifies as replacement property in an exchange if it is owned by the taxpayer for at least 24 months immediately after the exchange, and, in each of the two 12-month periods immediately after the exchange: (i) The taxpayer rents the replacement property to another person at a fair rental for 14 days or more, and (ii) The taxpayer's personal use of the replacement property does not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented at a fair rental. If a taxpayer reports a transaction as an exchange on the taxpayer's federal return expecting that the replacement property will meet the qualifying use standards, but the replacement property does not meet the qualifying use standards, the taxpayer, if necessary, should file an amended return and not report the transaction as an exchange.

Broad Definition of Personal Use. The taxpayer is deemed to have used a dwelling unit for personal purposes if used by: (A) the taxpayer or any other person who has an interest in such unit (including a tenant in common), or by any member of the family of the taxpayer or such other person; (B) by any individual who uses the unit under an arrangement which enables the taxpayer to use some other dwelling unit (whether or not a rental is charged for the use of such other unit); or (C) by any individual if rented for less than a fair market value rental. A taxpayer may rent the dwelling unit to a family member if the family member uses it as a principal residence (and not a vacation home) and the family member pays fair market rent. Some taxpayer usage may be allowed for repairs and annual maintenance too. See Section 280A(d)(2) and (3).

"Fair market rent" is determined based on all of the facts and circumstances that exist when the rental agreement is entered into, and all rights and obligations of the parties to the rental agreement are taken into account. A "dwelling unit" is real property improved with a house, apartment, condominium, or similar improvement that provides basic living accommodations including sleeping space, bathroom and cooking facilities.

Comment: How Does the Taxpayer Meet the Safe Harbor for a Vacation Home and Principal Residence? (1) Limit Taxpayer Use. The taxpayer (and any related parties under section 267, other than as a principal residence) can only use the property for 14 days per year (or 10% of the rental period if greater) for the two years prior to the exchange. The taxpayer may use the dwelling some additional days for repairs and annual maintenance too, but be prepared to prove actual work done. (2) Rent It Out. The property also must be rented to unrelated party for at least 14 days per year, but it does not have to be rented more than 14 days per year. (Alternatively, it can be rented as a principal residence to a related party).

Therefore, a taxpayer can take a personal residence or vacation home, rent it to a friend for 14 days per year for two years and then exchange out of it, with no question about whether it's held for investment. All rent must be fair market and the taxpayer should have evidence to prove this. Likewise, the taxpayer can do the same thing on the replacement property for the two years after the exchange (and this must be done if the replacement property is also the taxpayer's vacation home or future principal residence).

IRS Tax Relief Items for Disaster Situations

Special tax law provisions may help taxpayers recover financially from the impact of a disaster, especially when the president declares their location to be a major disaster area. Depending on the circumstances, the IRS may grant additional time to complete a 1031 exchange, file returns and/or pay taxes.

Typically in major disaster area relief grants, the IRS provides for extensions of 45-day and 180-day 1031 exchange requirements when a taxpayer is located in one of the affected counties, regardless of where the relinquished property or replacement property is located, or the taxpayer otherwise has difficulty meeting the exchange deadlines under the conditions in Revenue Procedure 2005-27, section 17; AND, the relinquished property was transferred (or the parked property was acquired by the EAT in a reverse exchange under Revenue Procedure 2000-37) on or before a stated date, related to the disaster, that is issued by the IRS.

The extension is usually for THE LONGER OF 120 days from the last day of the 45 or 180 day deadline, or until the date specified by the IRS.

If you believe your exchange may have been impacted by a major disaster area relief grant, please contact us or visit the IRS website for further assistance.

Guidance on Reporting Exchange of Dual Use Personal Residence/Business Property - Rev Proc 2005-14

Download Revenue Procedure 2005-14 (pdf).

Download Examples of How IRC §121and §131 Combine for Sales of Combination and Dual-Use Residential/Business Use Properties (pdf).

Revenue Procedure 2005-14 provides guidance on tax reporting issues under IRC §121and §131 for exchanges of property that are combination or dual-use residential and business/ investment property.

Background - A homeowner can exclude up to $250,000 ($500,000 on a joint return) of gain from the sale or exchange of a home if he owned and used the property as his principal residence for at least 2 of the 5-years preceding the date of sale (IRC §121). However, any depreciation taken on the property since May 6, 1997 is not eligible for the exclusion.

Treasury Regulation 1.121-1 issued in 2002 made it clear that the IRC §121exclusion of gain on the sale of a personal residence applies to an entire structure that is used partly as a personal residence and partly for business or investment use.

The business/investment portion of a combination or dual-use residential property is eligible for tax deferral under IRC §1031. Accordingly, residential property may be eligible for exclusion or tax deferral under both provisions of the Internal Revenue Code simultaneously.

Revenue Procedure 2005-14 gives six examples of how to report exchanges of property eligible for exclusion under IRC §121 and §131 in varying circumstances that can be summarized by the following examples. For purposes of these examples, assume the taxpayer is single and eligible for a gain exclusion of $250,000 under IRC §121.

Rental Property Now, Personal Residence in a Prior Year. IRC §121does not require a taxpayer to be residing in a residence at the date of sale in order to qualify for the gain exclusion. If the taxpayer owned and lived in a residence in two out of the past five years, it is eligible for gain exclusion under IRC §121 even if it is presently being used as a rental. The taxpayer can exclude gain up to $250,000 under IRC §121 except for any depreciation taken on the property since May 6, 1997. Gain resulting from depreciation is eligible for tax-deferral under IRC §1031. Realized gain is first excluded under IRC §121and then deferred under IRC §131. Cash boot of up to $250,000 received on the exchange would be tax-free under §121 even though the residence is currently being used as a rental property. Basis in the replacement property is increased by any gain excluded under IRC §121in excess of cash received under IRC §121. This can get tricky, see Rev. Proc. 2005-14 for specifics.

Combination Property, Two Structures on Same Property. If a taxpayer owns a property with a residence on it and a second structure used for business purposes, the property is a combination property. Part of the property is eligible for gain exclusion under IRC §121 and part of the property is eligible for tax-deferral under §131. The exchange has to be accounted for as if there were two properties being exchanged. The proceeds of sale has to be allocated between the §121and §131 property. The value of the replacement property has to be allocated between personal and business uses and realized gain is measured separately for each property. If the exchange of the business use of the relinquished property for business use replacement property results in a trade-down, there will be taxable boot on the exchange of the business portion of the relinquished property. Gain attributable to the business portion of the relinquished property cannot be excluded under IRC §121or vice versa. §121 realized gain in excess of the $250,000 exclusion cannot be sheltered by tax-deferral under the §131 portion of the property. Basis in the replacement property is measured separately for the personal residence and business portions of the property under the normal rules.

Dual-Use Property, One Structure Used Partly for Residential and Business Uses. Any gain resulting from cash or debt reduction boot realized on the exchange will be tax-free up to $250,000 under IRC §121even if the gain is allocable to or results from a trade-down on the business portion of the relinquished property. That is, except for any depreciation taken on the relinquished property since May 6, 1997. Variations on this theme can be summarized as follows -

  • As with Combination Property (see above) you have to imagine that dual-use property consists of two properties; §121property and §1031 property.
  • Cash (or debt reduction) boot received on the exchange is tax-free under IRC §121 up to a maximum of $250,000, even if it relates to the 1031 portion of the property.
  • Depreciation taken on the property that is allocable to the 1031 portion of the property can be tax-deferred under §1031. Depreciation taken on the §121 portion of the property since May 6, 1997 is taxable and cannot be sheltered by IRC §1031.
  • Gain on a §1031 exchange allocable to the personal residence portion of the property in excess of $250,000 is taxable under IRC §121 and cannot be sheltered under IRC §1031.
  • If a taxpayer is doing a 1031 exchange of a dual-use residence, taxpayer can elect to "take" a §121 gain exclusion on the exchange even though he received no boot from the exchange. In this case, the taxpayer receives a step-up in tax basis on the replacement property attributable to the §121gain exclusion.

Revenue Procedure 2005-14 does not address closing issues on exchanges of property used partly for residential purposes and partly for investment/business uses. Treasury Department Publication 523 (1998 - now replaced by new Pub. 523) instructed taxpayers with Dual-Use Property to treat the sale as the sale of two properties. Intermediaries frequently separated an exchange of dual-use property in a similar manner with separate settlement statements so that the taxpayer could cash-out on the personal residence part and roll the 1031 part thru an exchange. As a result of Rev Proc 2005-14, this will no longer be necessary for Dual-Use Property. It remains a good idea for sales of Combination Property.

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