THE ESSENTIALS OF A 1031 EXCHANGE ROBERT G. HETSLER You can easily see the power of a 1031 exchange in the following example. Both taxpayers sell a piece of investment real estate for $200,000. Both also have an adjusted basis of $100,000 and they each plan to acquire new investment real estate valued at $200,000 or more. Taxpayer 1 doesn’t take advantage of a 1031 Exchange, but Taxpayer 2 does. Who would you rather be? Taxpayer 1 (no exchange) Taxpayer 2 (with exchange) Sale Price: $200,000 $200,000 Adjusted Basis: $100,000 $100,000 Gain Realized: $100,000 $100,000 New Investment Property: $200,000+ $200,000+ Gain Recognized: $100,000 0 Federal & State Tax: $ 20,000 0 What Property Qualifies for an Exchange? Per the IRS code, “any property held for productive use in a trade or business or for investment can be exchanged for ‘likekind’ property.” The term “like kind” refers to the purpose of the investment rather than the form the investment takes. This means an investor can trade an apartment complex for a singlefamily residence, shopping center, raw land or office building. The only requirement is that the nature of the replacement property is similar to the relinquished property. However, the IRS specifically excludes certain categories of property, regardless of its use in trade or business. These categories include stocks, bonds, securities, notes and interests in partnerships. Also excluded is property held primarily for sale, such as those residential properties purchased to “flip” and vacant land to be developed into a home. This means that flippers or private developers cannot use a 1031 exchange for their business or traderelated properties. Finally, primary residences are also excluded from 1031 exchanges.