The paramount principle of a 1031 exchange is to defer capital gains tax when you replace your business/investment real estate with other business/ investment real estate. This is known as a “like-kind” exchange, and today all real estate (including mineral rights and fractional interests) is “like-kind” with all other real estate. Click here for a summary of 1031 exchange requirements. REPLACE YOUR RENTAL PROPERTY WITH A REIT… WITHOUT TAXES!
In the last category are structures that seem like real estate—partnerships, real estate operating companies, LLCs and REITs—but do not qualify because technically the investor owns an interest in a company or partnership, not an interest in the underlying property. More specifically: in a 1031 exchange, you cannot sell a rental property and re-invest the sales proceeds into a REIT. This may seem counterintuitive, but 1031 rules explicitly require taxpayers to replace their relinquished property with real estate they own directly. The only exception to this rule is found in IRS Revenue Ruling 2004-86, which treats a beneficial interest in a trust created under Delaware law (subject to certain caveats) as a directly-owned fractional interest for 1031 purposes. Click here for a detailed overview.
However, not all real estate satisfies the “business or investment” requirement of a 1031 exchange. Common exclusions are:
• Primary residence
• Property used as personal vacation property
• Developer inventory
• “Flip” property
• Investment vehicles that own real estate
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