Section 1031 of the Internal Revenue Code provides that no gain or loss is recognized if property "held for productive use in a trade or business or for investment" is traded solely for the "like-kind" property that also is to be held for investment or used in a trade or business. The essential element of such a trade is a reciprocal and interdependent transfer of one property for another, as opposed to a simple sale and repurchase. Effectively, I.R.C. Section 1031 exchanges allow investors to "sell" property and reinvest the proceeds in another without having to pay taxes that would otherwise be recognized (owed) on gain from the sale. The payment of such capital gains tax is deferred, representing only a potential tax, which is not owed unless and until the replacement property is sold in a subsequent taxable transaction. The taxes may, in some cases, be avoided all together. One example of this would be if the replacement property passes through an estate and its basis is stepped up to the market value at the time of death.

The primary advantage of exchanging under I.R.C. Section 1031 is the preservation of working capital. If you sell property you must pay taxes on any recognized gain. These funds will no longer be available to you for investment. The capital gains and recapture taxes you must pay upon a sale can amount to almost 40% of your gain. In a tax-deferred exchange, all of your profit may be used to acquire replacement property, not possible if you deplete your working capital by paying taxes. 1031 exchanges allow greater net profits, the purchase of larger or additional investment property, and a faster pyramiding of wealth.

If and when you elect to sell, as opposed to exchange, your replacement property, then the deferred gain will become taxable. With proper planning, you may defer the tax for your entire investment career.

Generally, all real property is "like-kind" to all other real property within the US. Like kind property is property which is not identified as your personal residence or second home, and was not acquired for resale or considered inventory or dealer property, only like kind property may be traded under the I.R.C. Section 1031 exchange rules. The property relinquished in the exchange must have been either productively used in your trade or business, or held for investment, i.e., you must have effected a "qualified use" of the property. Likewise, it must be your intention as you acquire your replacement, to either hold that property for investment or use it for a business purpose

The words "like-kind" refer to the nature of your use of the property, not it’s character, grade or quality. For example, real property is not of like kind to personal property because they are of a different nature and character. Conversely, vacant land, for example, is of like- kind to improved property as the two differ only in their grad/quality. Raw land, condominiums, single family residences, shopping centers, apartment buildings, farm and ranch land, commercial real estate, industrial property, second homes converted to investment property, and almost all other realty are of like-kind with respect to their intrinsic nature and character and may, therefore, be interchangeably exchanged. With limited exceptions, any real estate meeting the above tests can be exchanged for any other real estate. In addition, the rules excepting incidental property from the identification requirements should not be construed as meaning such property will be considered like- kind realty.

Remember, the final regulations for "Multi-Asset/Personal Property" exchanges provide for very narrow like-kind qualification of any non-realty business or investment property, which may be transferred together with real estate in your transactions. For example, any furniture, manufacturing or the equipment, autos, or artwork, etc. transferred in addition to real estate is not like kind to realty received as replacement property. The definition of realty is determined on a state by state basis within the United States, and any person wishing to exchange should determine the definition of realty according to the state or states where the relinquished and replacement properties are located.

Since the Code does not clearly define the term "held for productive use in a trade or business or for investment," the definition is subject to interpretation and has given rise to great uncertainty. Unproductive real estate that is "held by a non dealer for future use or for future realization of the increment in value" (in other words, held for appreciation) is held for investment and qualifies. Qualifying property not held for investment must be used in a trade or business that you are engaged in. Practitioners generally agree that property which was acquired for a qualifying use but which is now inactive will continue to qualify. Theoretically, your intention to hold for productive use in a trade or business or for investment must satisfy the statutory requirement of the Code. However, a substantial risk of invalidation may exist in the event there is no obvious trade or business use and/or the holding period is of short duration. In such circumstances, the burden of proof weighs heavily and you are well advised to carefully document your intention to hold for investment. Lastly, minimum and incidental use of otherwise qualifying property may not necessarily disqualify property.

Yes. The following property is specifically excluded under I.R.C. Section 1031 and therefore cannot be of "like-kind":

• Stock in trade or other property held primarily for sale
• Stocks, Bonds, Notes or other Securities or Evidence of Indebtedness or Interest
• Interests in a Partnership
• Certificates of Trust or Beneficial Interest
• Chooses is Action
• Real Property located within the United States is no longer like-kind with Real Property located outside of the United States

No. Personal residences are subject to their own special rules, and cannot be exchanged under I.R.C. Section 1031.