A 1031 on Residential Property? It's Possible

Section 1031 of the Internal Revenue Code, also known simply as 1031, defers taxes for gains on any property or asset if they're reinvested in a like-kind exchange. If you sold a $100,000 property for twice the amount, the $100,000 gain won't be subject to tax as long as it's invested in another property. This is in line with what Section 1031 actually says. It states that “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business.”

Speaking of trade or business, does this imply that simple homeowners aren't qualified for a 1031? While it states that the property must be for productive use, experts say homeowners can file a 1031 in a number of instances. In this case, you need to know the so-called “two-of-the-last-five-years rule” where the homeowner must have lived in the house for two years. It also states that the house has been turned into an investment property for the next three years.

One way to turn a residential property into an investment is by renting it out. Homeowners can move out of the house after their second year of residing there, but have to rent it out for the next three years to qualify for a 1031. Make sure you don't make your new home your primary residence before the two-year period, although there are efforts to reduce the time frame to just one year.

What Should and Shouldn’t be Done in Real Estate Exchanges

Disposal and acquisition of property under the 1031 Exchange section of the Internal Revenue code can be complicated, but it is more lucrative than other real estate investments. Under this section, a property can be swapped for another if they are like-kind or of the same types (i.e. business-for-business like an office for a shopping center). What makes this deal sweet is its virtual exemption from capital gains taxes. For prospective investors in this profitable business undertaking, the following dos and don’ts apply as in any other venture:

Do hire a certified public accountant, real estate agent, or any financial expert that has not seen your books in the last two years. The Internal Revenue Service publication 544 disqualifies monetary professionals who have worked on your behalf from handling property trades.

Do be mindful of the time element. A 1031 exchange has 180 days to be completed, with 45 days to spend in identifying a suitable property. Remember that there are no extensions for these transactions, and that holidays and weekends are included in the six-month period allotted to close the deal.

Do not trade in a property that has lesser value than the one you’re looking at. In such cases, capital gains taxes will kick in (any excess money from the exchange is taxable).

On Business and Equivalent Exchange

For as long as Man has roamed the earth and put value on different objects, people have always made deals under the concept of fair trade. Even back in the days when money was yet to be invented, people bartered their food, belongings, and services looking to get something at least of equal value in return. This vague concept of “equivalent exchange” is something that has propagated throughout the years, although now it's quite more complex.

In modern times, it's easy enough to believe that money is one of the main, if not the main, movers of societies. Almost all people are born, go to school, and eventually go to work fully accepting of the idea that earning money is the path to survival, comfort, and even happiness. Left and right, people are moving up career ladders and businesses are being built out of the ground, and all of this happens still following certain rules and laws on exchanges and business transactions. There are, decidedly, a whole lot of things you can do with money.

Even money, though, is still a representation of what humans consider to be “valuable”, and exchanges don't necessarily have to involve money—at least directly. In fact, it is possible to exchange entire properties and businesses nowadays, and while these things do involve money at certain points, the exchange itself is not mainly about money. At the root of it all, things just have to be fair because the moment it's not, trouble brews.