Added to the Internal Revenue Code in 1921, Section 1031 is the best planned escape from capital gains tax and recapture of depreciation ever conceived. There is no reason to pay any tax that can be deferred throughout your lifetime and it will not leave a burden for your heirs.
The concept is a simple one; reinvest upon sale of your property with the acquisition of “like-kind” assets facilitated with the assistance of a Qualified Intermediary. For real property, the choices are limited by the four corners of the United States and the use as commercial or business property. It is possible to sell land in Maine and acquire a condo in Arizona, all tax deferred. Don’t let the “like-kind” attributes confuse the outcomes. All real estate is “like-kind” to all other real estate. The character or quality of the property is never considered, it is always the value that is exchanged for new replacement property. Sell a $500,000 property and acquire $500,000 worth of new property(ies). Under the simple rules, you can sell one property and acquire up to three new properties, all without regard to the value of the new property. This provides an opportunity for diversification of the asset and its geographic location(s).
Section 1031 does not provide an escape from tax upon the sale of personal use property. Personal residences are guided by Section 121 of the Code and all other personal use property (vacation/seasonal homes) is exposed to tax. However, a planned escape is possible by changing the use to business or investment two years prior to sale. The property acquired from your grandmother 15 years ago for no value and used as a summer escape by you and your extended family can be made to qualify. It requires that you cease the personal use, rent it to non-related parties for the next two years and then acquire investment property with the proceeds and rent the new property for the following two years. There is no penalty for converting the property after that time to personal use once again.
In the same manner that you plan all significant events, plan your great escape from capital gains tax now.
