Performing 1031 Tax Deferred Exchanges on your investment properties is probably the best method to achieving explosive growth in your real estate portfolios.  Before we go into exchanges for investment properties, let's talk about the new change in tax laws for primary residences.

The Taxpayer Relief Act of 1997 changed Internal Revenue Code treatment for the sale of a personal residence to allow a single taxpayer a $250,000 exclusion from capital gains taxes.  Married couples receive a $500,000 exclusion.  The taxpayer must hae resided in the property two of the last five years.

This exemption can be used once every two years.  Meaning you can change your primary residence every two years and not be taxed on the capital gain.  There was a time when it used to be just a one time exemption.

On the other hand, if an investor sells an appreciated property they must pay a capital gains tax.  But, property that qualifies for preferential tax treatment under Internal Revenue Code Section 1031 is treated quite differently.  Internal Revenue Code Section 1031 states:

"No gain or loss shall be recognized if property held for productive use in a trade or business or for investment purposes is exchanged solely for property of a like-kind."

Therefore, an investor using IRC Section 1031 can exchange raw land for a rental home, an apartment complex for a shopping center or rental houses for an office building.  

The use of a property is a key factor in determining the tax treatment.  It must be a "like-kind" transaction.

What is "Like-Kind" Property?

Investors often mistakenly believe that they must acquire a property exactly like their relinquished property.  They are surprised to learn that a wide variety of properties can be considered "like-kind."

The term "like-kind" does not refer to a type of property.  Instead, it addresses the intended use of property.  Provided the property is initially acquired and held for either business or investment purposes, it can qualify as a suitable replacement property under IRC Section 1031.

For example, any of the following can be considered "like-kind" property exchanges:  a duplex for a fourplex, bare land for improved property, a rental house for a retail center or an apartment building for an office building.  Investors do not have to exchange for exactly the same type of property as the one that they just sold.

Some examples of items that are not considered "like-kind" are as follows:

- Stock in trade or other property held primarily for sale

- Stocks, bonds, or notes

- Other securities or evidence of indebtedness

- Interests in partnerships

- Certificates of trust or beneficial interest

In addition, the Code was amended in 1989, rendering property outside the United States as not "like-kind" to US property.

We will continue on the 1031 Exchange code on next month's article.