Business owners understand the elements of a good deal, so in a challenging economy it is essential to make sure to protect their interests in every transaction. Investors who are looking for tax-deferred options for doing just this may have considered 1031 exchanges.
Under the Internal Revenue Service IRC Section 1031, there are ways to postpone the profit on the sale of business or investment property through reinvestment of the proceeds in a similar property, so long as it is a qualifying like-kind exchange. For Delaware business owners, it makes sense to find out more about their tax-deferred options, as it can be tricky to thread the needle to avoid triggering a taxable gain in the exchange.
What is a 1031 exchange?
The IRS allows investors to defer a gain when they sell real estate property under Section 1031, and the like-kind exchange can be for property of lesser value. But it is important to remember that reinvesting a gain in similar property makes it tax-deferred, but not tax-free.
Qualifying entities for a 1031 exchange include business property and investment owners as well as any taxpaying entity, including:
- C or S corporations
- General or limited partnerships
- Limited liability companies
In a tax-deferred exchange, there is an exchange of properties that is usually simultaneous. However, it cannot be a simple sale and purchase transaction by the owner, as this would be a taxable exchange. For it to be deferred, there must be a third-party entity and exchange agreements that create a qualifying integrated transaction. Fortunately, in such a transaction the property is direct-deeded, and the intermediary does not appear in the chain of title.
What qualifies as like-kind property?
Under tax law that went into effect in 2018, a 1031 exchange can only apply to real property and not personal or intangible property, although a transition rule allows some exceptions.
Like-kind property does not mean the same kind or quality of property, such as a vacation home, undeveloped property, or office building. Any real property is exchangeable, so long as the entity holds or exchanges it for the investment or productive use purposes of the business. Some examples of qualifying properties include:
- Convertible farmland for real estate
- Oil and gas royalties
- Tenant-in-common interest, or rental properties
Properties that do not qualify include stocks and securities, partnerships, property received by judicial proceeding, or foreign real estate interests.