Real estate inventory is very scarce right now, which has caused a lot of frustration among investors engaging in 1031 exchanges. This scarcity has caused many people to try and get creative with their replacement properties. However, you need to be very careful in how you approach this as the IRS has very strict rules on what does and does not qualify for 1031 treatment.
Buyer Beware
Here’s an example of a potential “solution” to the scarcity problem that does NOT work for 1031 exchange purposes.
Let’s say you are looking to sell your investment property in a 1031 exchange transaction and you want to buy a gorgeous single-family home as your replacement property. Then you want to move into that new single-family home and rent out your old home.
Here’s the issue with that – your 1031 replacement property has to be used for investment or business purposes. If you move into that home, that will likely be considered personal use by the IRS.
Some may try and argue that in this scenario you’re just substituting the old home as the new rental property, but I don't think the IRS is going to look at it that way.
This is just one example of a creative “solution” to a 1031 problem that will likely not work out in the taxpayer’s favor. It’s important to be very mindful that when you're doing an exchange, you want to bring your accountant, your tax preparer, your tax attorney, and your qualified intermediary to ensure that your exchange is going to be successful.
Like-Kind
The like-kind provision in section 1031 is very broad. Most real estate in the United States can be considered like-kind to most other real estate in the United States. So an unimproved farm is considered like kind with the IDS Center in downtown Minneapolis. They're both real estate. The character of the farm and the character of the IDS Center are both real estate so you can do an exchange of real estate that may not be similar but you can still exchange within the United States real property for real property.
That it gives investors a lot of options for potential replacement properties when considering a 1031 exchange.
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
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