Brandt Nicholson, JD, Principal

The "1031" Reinvestment Provision

The Internal Revenue Code, section 1031 provides a means for deferring gain recognition (i.e., no capital gain tax,) on the sale of real or personal property held for investment (i.e. typically a rental, or undeveloped land) or use in your trade or business (excluding inventory) that has appreciated significantly in value.

The "like kind" requirement is very loosely construed with respect to real property but is a significant requirement for personal property. Each is limited to property located in the United States. Personal property must be exchanged for other "like kind" personal property (i.e. paintings for other paintings). Residential real estate may be exchanged for commercial property, undeveloped land, etc. anywhere within the United States. A lease with 30 years or more remaining (including options to renew) may be exchanged for a fee interest.

Exchanges are not "tax free" in that the basis of the replacement property (i.e. purchase price) is reduced on acquisition by the amount of the gain not recognized on the sale of the exchange property by reason of the exchange.

It is often advisable to integrate a contemplated exchange with other estate planning techniques, such as family or living trusts.

For 100% deferral of gain recognition, one must "trade up." The simplest rule is equal or greater in price and equity. Thus, if you sell your present investment property for $300,000 you should acquire replacement property(s) for at least that amount and invest the entire net sale proceeds in the new property(s).

You may consolidate several exchange properties for one replacement property or, sell one exchange property for several replacement properties. See "Delayed Exchanges" for the critical, and often tedious, identification rules.