When it comes to deferring capital gains taxes on the sale of an investment property, the IRS tax code 1031, commonly known as a 1031 exchange, allows landowners to swap one property for another of equal or greater value while deferring capital gains taxes incurred on the sale of their relinquished property. However, it’s important to understand exactly which assets are eligible for a 1031 exchange.

In this article, we’ll look at the wide range of properties that qualify for a 1031 exchange, as well as any exceptions to be mindful of.

What Kinds of Properties Qualify for a 1031 Exchange?

The main focus of the 1031 exchange is real estate, so investors and landowners can exchange various types of properties under IRS tax code 1031, including:

Residential Properties

This includes single-family homes, condos, townhouses, and duplexes. Any kind of property that generates rental income such as an apartment complex or vacation rental like an Airbnb is eligible.

Commercial Properties

Office buildings, retail spaces, industrial properties, and warehouses are all eligible for a 1031 exchange.

Vacant Land

Undeveloped land can also be exchanged, given that it is held for investment or used in a trade/business.

Investment Properties

This category encompasses a wide variety of properties held for investment and income-generating purposes, including shopping centers, hotels, and more. Farmland also falls into this category so long as the farmland is held for business/trade purposes. Personal-use farmland such as family or hobby farms do not qualify for a 1031 exchange.

1031 Exchange Restrictions

During his recent appearance on the National Land Podcast, Director of Education for Accruit David Gorenberg explained two primary restrictions when dealing with 1031 exchanges. Gorenberg stated, “Any asset class of real estate on the outbound side [can be exchanged for] any asset class of real estate on the inbound side and there are really only two caveats to that. Number one, your personal residence and your second home don’t count. It must truly be an investment property like an Airbnb, a farm, an office building, whatever it is. When you buy, it’s the same thing: no personal-use property.”

Gorenberg went on to explain that the second caveat deals with the location of the sold and purchased properties, stating, “If we sold domestic real estate, then we need to buy domestic real estate. So you can’t sell in Idaho and buy in India. Foreign real estate is like-kind to foreign real estate, and domestic real estate is like-kind to domestic real estate.”

The Like-Kind Requirement

One of the most important aspects of the 1031 exchange is that the relinquished property must be exchanged for a property of “like-kind.” This means that properties involved in the exchange must be of the same nature or of a similar use, even if they differ in quality. For example, a rental house could be exchanged for an apartment building since they are considered “like-kind” in the world of real estate.

Does Land Need to Be Income-Producing for a 1031 Exchange?

One of the common misconceptions about 1031 exchanges is that the property must be income-producing to qualify for a 1031 exchange. This is not necessarily true, as the main requirement is that the property be classified as an investment. 

David Gorenberg explained this misconception, stating, “It doesn’t necessarily have to be income-producing, and I’ll give you an example. I mean, I could have bought 500 acres to let my cattle graze. So could you argue that it’s income-producing because my cattle are grazing there? Yeah, I guess you could.”

So long as a landowner can prove that the property has served a business use, it can be classified as “income-producing” and qualify for a 1031 exchange. Gorenberg went on to elaborate, “The statute says that the property must be held for productive use in a trade or business or for investment. So let’s give another example. Let’s say you have a construction company, and that’s where you park your dump trucks and bulldozers at the end of every shift. That property is not producing income, it’s where you’re parking your machinery. But it’s clear that there’s a business use there, right?”

If you’ve got more questions about whether your property qualifies for a 1031 exchange, contact your local Land Professional today!