The Trump Administration recently passed the Tax Cut and Jobs Act, a set of tax reforms which redefine what can be claimed as property in 1031 or, ‘like-kind’ property exchanges.
Before we can understand the Trump Administration’s changes, we must understand the basics of a 1031 property exchange:
- The 1031 tax exchange (also referred to as a Starker Exchange) is most frequently employed in real-estate exchanges.
- The 1031 law provides exemption from tax when one property is swapped or traded for another property of greater or equal value.
- The 1031 exchange is widely-recognized as the best way to defer taxation whilst accruing investment properties with greater profit potential.
Here are some basic 1031 exchange examples in practice:
Property Owner A would like to sell his apartment building in West Philadelphia for a home of relative value in Chestnut Hill, owned by Property Owner B.
Property Owner A and/or B would like to take advantage of the 1031 code, with which they can circumvent taxation for the new real-estate purchases.
The owners have a few options:
The most common 1031 exchange is a delayed exchange, by far the most popular for like-kind 1031 exchanges. Property Owner A puts his unit building up for sale.
He must market and advertise his unit building and identify a like-kind property he’d like to buy within 45 days of beginning the process (Property Owner B’s Chestnut Hill house).
Property Owner A must sell his unit building within 180 days of start of the exchange process. Property owner B simply sells the Chestnut Hill property to Property Owner A and then Owner B may pursue his own 1031 exchange.
A less common but equally viable option is a simultaneous 1031 exchange.
Property Owner B may desire Property Owner A’s apartment unit building in West Philadelphia. In this case, the two owners simply trade units simultaneously.
There are other, less common variations on 1031 exchange, but these examples are the most frequently utilized. In all cases of 1031 exchange there are some basic restrictions:
All property exchanged must be commercial, investment, or for-profit; owners’ homes and property for personal use do not qualify.
Additionally, all 1031 transactions must be overseen and mediated by a qualified intermediary (QI), an insured third party responsible for following deadlines and setting up secure transactions and accounts for the exchange. A QI is often someone with a finance, law, or real-estate background.
The 1031 tax law has recently undergone massive overhaul with the Trump Administration’s new legislation. Prior to the 2017 Tax Cut and Jobs Act, the definition of ‘property’ was quite loose.
Many types of property other than real-estate were exchanged under the 1031 exemption: cars, airplanes, even cryptocurrency.
Cryptocurrency has previously been categorized in various governmental rulings as property.
This classification was assigned in a greater legislative effort to avoid recognition of crypto as fiat currency.
Soon after these rulings, clever investors saw an opportunity to trade cryptocurrency as 1031 commodities.
The new 2017 tax law eliminates this possibility, along with the trade of other property-like items in a 1031 exchange and qualifies only investment realty as covered under the exemption.
Complications may arise for properties in-process, particularly those which began the exchange process before the Tax Cut and Jobs Act’s passing on December 22nd, 2017.
Property investors in 2019 would be wise to read the rules established in the new legislation in order to maintain compliance with all changes.
Although new law has made the process more specific, the 1031 like-kind law remains the most effective way to accrue tax-delayed wealth through property exchange.