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33rd Company News

1031 Exchanges: The Basics for Beginners

Tom Sedlack - Thursday, July 28, 2022

According to recent findings, new home sales increased by 4.5% compared to previous years. So investing in a rental property is a great way to generate a second income.

But what if you want to sell your investment property? You would inevitably have to pay tax on that sale unless you qualify for a 1031 exchange.

1031 exchanges are a way for investors to sell one investment property and use the proceeds to purchase another property for investment. This sale will not require paying taxes.

If you're looking to defer taxes on your investment property sale, then a 1031 exchange may be a good option. Keep reading to learn more.

What Is a 1031 Exchange?

1031 exchanges are property transactions. These transactions are valid when one property exchanges with another classified as "like-kind." Any losses or gains are deferred for income tax purposes through this transaction.

Typically, when a homeowner sells their property, any losses or gains on the sale are calculated within the tax year in which the sale occurred. However, this is not the case with 1031 exchanges.

In 1031 exchanges, the homeowner must exchange the property for a link-kind property to qualify. Any loss or gain is deferred until the replacement property is sold.

Which Properties Quality for 1031 Exchanges?

A property is eligible for a 1031 exchange when it is a "real property." Real property is recognized under local jurisdiction or the laws of the state in which the property is when the exchange takes place.

Taxpayers must hold exchanged properties for an eligible purpose to qualify for a 1031 exchange. These can be any of the following:

  • To qualify for the 1031 exchange, the taxpayer can hold the property for productive use or investment purposes.
  • Property such as land and improvements to it are eligible for 1031 exchanges.*
  • for water and the air above ("superjacent") the water (e.g., boat slips or a marina).
  • A 1031 exchange is also available for unsevered natural products of land**

*Buildings and walls, floors, and ceilings are structural components of buildings that are inherently permanent.

**Growing crops, harvesting timber, mining, wells, and other natural resources are examples of the land's unsevered natural products. Once they're severed or removed, natural products like crops, timber, water, ore, and minerals won't qualify for an exchange.

What Is a Like-Kind Property?

A property's nature and character determine if it is like-kind. It doesn't matter whether improved or unimproved; real property is often considered like-kind to any other real property. For example, when determining if the property is like-kind, the IRS does not consider the grade or quality.

Looking For Someone to Manage Your Investment Properties?

Investing in property is a smart way to invest your money. Take time to understand how 1031 exchanges work so you know when it can apply to you. For example, when you sell an investment property.

If you're looking for top-quality property management services in Minneapolis, visit our property management page for more information and to get in touch.


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