§ 1031 Like-Kind Exchanges

Under § 1031(a), no gain or loss is recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment. The TCJA limited § 1031 to real property exchanges effective for exchanges completed after December 31, 2017, with limited transitional relief.

The like-kind standard

Real property is broadly like-kind to other real property held for the qualifying use. § 1.1031(a)-1(b) defines “like kind” to refer to the nature or character of the property and not to its grade or quality. Improved real property may be exchanged for unimproved real property; commercial for residential; fee simple for leasehold of 30 years or more; partial interests (TIC and Delaware statutory trust) for fee interests, subject to specific guidance.

Property held primarily for sale (dealer property) does not qualify under § 1031(a)(2). The dealer-vs-investor analysis turns on facts and circumstances similar to the capital-vs-ordinary analysis under § 1221.

Deferred exchange mechanics

Under § 1031(a)(3) and § 1.1031(k)-1, a deferred exchange requires:

• Identification within 45 days: in writing, signed by the taxpayer, delivered to the QI (or another non-related party). Identification rules under § 1.1031(k)-1(c)(4): 3-property rule, 200% rule, or 95% rule.
• Closing within 180 days (or the due date of the return for the year of the exchange, including extensions, if earlier).
• Use of a qualified intermediary under § 1.1031(k)-1(g)(4): the QI is a non-disqualified person who acquires the relinquished property, transfers the proceeds, and acquires the replacement property. Constructive receipt by the taxpayer during the exchange period kills deferral.
• Same taxpayer rule: the taxpayer that sold the relinquished property must be the same taxpayer that acquires the replacement property. SMLLC pass-throughs are generally fine; multi-member entities require careful structuring (the “drop and swap” analysis).

QI safe harbor and disqualified persons

The QI must not be a disqualified person under § 1.1031(k)-1(k): agent of the taxpayer at any time within the prior two years (including the taxpayer’s attorney, CPA, real estate broker), or a person related to the taxpayer under § 267(b) or § 707(b). The taxpayer’s longtime CPA who is also the QI is a common DQ trap.

Exchange funds must be held in a manner that prevents the taxpayer from receiving, pledging, borrowing, or otherwise obtaining the benefits of the proceeds. The QI agreement must include the appropriate restrictions on access.

Boot

Gain is recognized to the extent of money received plus the fair market value of other non-like-kind property received under § 1031(b). Common boot sources: cash received from the QI at the end of the exchange (failure to reinvest all proceeds); net debt relief (the mortgage on the replacement is lower than the mortgage relieved on the relinquished, computed net under § 1.1031(d)-2); receipt of non-like-kind property as part of the transaction.

Boot recognition follows the recapture-first rule: § 1245(b)(4) and § 1250(d)(4) apply boot first against any unrecaptured depreciation, then against any remaining gain.

Basis in the replacement property

Under § 1031(d), the basis of the replacement property is the basis of the relinquished property, decreased by any money received and increased by any gain recognized (or decreased by any loss recognized). Practically: basis carries over. Depreciation continues under the rules of § 1.168(i)-6: the exchanged basis is depreciated over the remaining recovery period using the same method as the relinquished property; excess basis (cash paid in addition to the exchanged basis) is depreciated as new property under its own MACRS schedule. Taxpayers may elect under § 1.168(i)-6(i) to treat the entire replacement as a new asset.

Bonus depreciation under § 168(k)(2)(E)(ii) is available on the excess basis of the replacement (and, in some structures, on the exchanged basis), subject to the unrelated-party and prior-use rules.

Reverse and improvement exchanges

Rev. Proc. 2000-37 provides a safe harbor for parking arrangements in which the QI (or an exchange accommodation titleholder, EAT) takes title to the replacement property before the relinquished is sold. The 45/180-day timing still controls; the parking structure pre-positions the replacement.

Improvement (build-to-suit) exchanges allow the taxpayer to apply exchange proceeds to construct improvements on land owned by the EAT, then take title after construction. The improvements must be completed within the 180-day window for their cost to count toward the exchange.

Related party rules

Under § 1031(f), exchanges with related parties as defined in § 267(b) or § 707(b) trigger a two-year holding period for both sides; if either disposes within two years, the original deferred gain is recognized in that year. Several common “swap and drop” structures fail this analysis. Rev. Rul. 2002-83 addresses related-party basis-shifting concerns.

Reporting

Form 8824 is filed with the return for the year of the exchange (the year the relinquished property is transferred). Both legs of the exchange are reported, including identification of the QI, dates, properties, basis allocation, and boot computation.

Planning notes

1. Start QI selection before listing. The QI agreement and identification template should be in hand by the day of the relinquished closing.
2. Drop-and-swap timing. Restructuring a multi-member entity to enable an exchange should happen well before the relinquished closing; doing it on the eve of the sale invites a step-transaction challenge.
3. Excess basis and cost seg. The replacement’s excess basis (cash paid above the exchanged basis) is fresh basis for cost segregation. The exchanged basis carries the prior class lives; the elected treatment under § 1.168(i)-6(i) changes this.
4. Boot from net debt relief. Common with refinances near closing. Model the net mortgage position before the relinquished closing, not after.
5. State conformity. California and several other states have separate reporting (Form 3840) and conformity quirks; verify before assuming federal treatment carries through.