Properties involving mixed uses (combining personal use and business use) can be exchanged under Section 1031. The portion of the property used as business use will qualify for tax deferral treatment under Section 1031. Depending on its use, the portion of the property used for personal use may qualify for the $250,000 ($500,000, if married filing jointly) primary residence exclusion (under Section 121, also known as the Home Sellers’ Exemption). Additionally, you can acquire a property that would have mixed uses. Some examples of properties that may have mixed uses are owner-occupied duplexes, bed & breakfasts and farms.
Maximizing your Tax Deferral
To maximize your tax deferral, you must acquire replacement property equal to or greater in value than the net selling price of the relinquished property (contract sales price less routine transaction expenses). The equity in the replacement property must be equal to or greater than the net equity of the relinquished property (contract sales price less routine transaction expenses less the mortgage payoff, if applicable). A trade-down in value or equity creates a taxable event. You are taxed on the greater trade down.
Like-Kind Requirement
Both the relinquished property and the replacement property must be held for investment or productive use in a trade or business to meet the requirement. Like-kind refers to the use of the property, not the specific "kind" of property.
- Properties may be located anywhere within the United States.
- More than one property may be sold or acquired.
- Examples of like-kind property that can be exchanged if used for business use investment under section 1031 include vacant land, office buildings, duplexes, apartment buildings, single-family homes used as rentals, warehouses, farms, Bed & Breakfast, 30-year leasehold interest, utility easements, conservation easements, etc. A tenant-in-common (TIC) interest may also qualify.
- Tangible and intangible personal property are no longer eligible for tax deferral under Section 1031. This includes furniture, equipment, franchise agreements, livestock, and airplanes. Other ineligible assets include primary residences, vacation homes, “flips,” stocks, bonds, notes, mortgages, cash, equipment, goodwill, inventory, or an interest in a partnership.
Same Taxpayer Requirement
Any taxpayer or tax entity can complete an exchange. However, the title to the replacement property should be taken the same way the title of the relinquished property was held. The only exception to this rule would be the use of a disregarded entity, such as a single-member limited liability company (LLC). Except in a community property state, a husband and wife wishing to use a single-member LLC to acquire the replacement property would have to create a separate single-member LLC for each spouse and each LLC would acquire a 50% tenant-in-common interest in the replacement property. If using a single-member LLC, the taxpayer would have to elect to be treated as a disregarded entity for tax purposes. Some other disregarded entities, such as an Illinois Land Trust (Rev. Ruling 92-105) and a revocable living trust (Rev. Rul. 92-105, Rev. Rul. 70-376, and Rev. Rul. 88-103) will also qualify.
