DEFINITION of 'Section 1031'

Section 1031 is an Internal Revenue Code (IRC) provision that defers tax on qualifying exchanges of like-kind real estate. Section 1031 is also known as the Starker Loophole. Qualifying Section 1031 exchanges are called 1031 exchanges, like-kind exchanges, or Starker exchanges.

BREAKING DOWN 'Section 1031'

Section 1031 defers tax on properly structured 1031 exchanges. For 1031 exchanges concluded prior to December 31, 2017, like-kind property includes a broad range of real and tangible personal property held for business or investment such as franchises, art, equipment, stock in trade, securities, partnership interests, certificates of trust, and beneficial interests. For 1031 exchanges concluded after December 31, 2017, recently enacted tax legislation makes it clear that the only permissible property is a business or investment real estate. As a result of this change, this article focuses on 1031 exchanges of like-kind business and investment real estate concluded after December 31, 2017.

Section 1031 Real Estate

Section 1031 property, for 1031 exchanges concluded after December 31, 2017, is real estate held for investment or for productive use in a trade or business. The real estate must be located in the United Sates to be like-kind.

Section 1031 Steps to a Tax-Deferred Exchange

Section 1031 defers tax on swaps of like-kind real estate done in a timely manner. The most important steps to a properly structured 1031 exchange are: (1) Replacement real estate must be like-kind. (2) Tax must be paid on any “boot” in the year of the 1031 Exchange. (3) Once business or investment real estate is sold, replacement like-kind real estate must be identified within 45 days and acquired within 180 days. Each of these steps are discussed in greater detail below.

Step 1: Like-Kind Real Estate Defined

Section 1031 defines like-kind as real estate that is held for productive use in a trade or business or for investment. Section 1031 defers tax when this real estate is exchanged in a properly structured 1031 exchange for like-kind real estate that continues to be held for productive use in a trade or business or for investment.

Step 2: Boot Defined

Section 1031 allows an investor to give or receive cash, liabilities or other property that is not like-kind in addition to the like-kind real estate exchanged. Cash, liabilities or other property that is not like-kind and that is given or received in a 1031 exchange is called “boot.” Boot triggers taxable gains or losses in the year of the exchange. The taxable amount that is not deferred by Section 1031 is the amount of the boot. The taxable amount that is deferred by Section 1031 is the capital gain or loss on the like-kind real estate exchanged.

Step 3: Exchange Timing

Section 1031 gives a taxpayer who sells business or investment real estate 45 calendar days from the closing to identify up to three (and under certain circumstances four or more) like-kind replacement real estate properties. The replacement must be acquired and the 1031 exchange completed by the earlier of 180 calendar days or the due date (with extensions) of the taxpayer’s return.

Reporting the 1031 Exchange 

Even though tax is deferred and no gain or loss is recognize, the 1031 exchange must be reported on Form 8824, Like-Kind Exchanges. Form 8824's instructions explain how to report the details of the 1031 exchange. Gain recognized because boot was received is reported on Form 8949, Schedule D (Form 1040), or Form 4797, as applicable. If depreciation must be recaptured, then this recognized gain may have to be reported as ordinary income.

RELATED TERMS
  1. Like-Kind Property

    Like-kind property refers to two pieces of real estate that can ...
  2. Reverse Exchange

    A reverse exchange is a type of property exchange wherein the ...
  3. Section 1250

    Section 1250 of the U.S. Internal Revenue Service Code states ...
  4. Section 1245

    Section 1245 is a tax law codified in the Internal Revenue Code ...
  5. Amount Recognized

    Amount recognized is income or loss you must report on your tax ...
  6. Real Estate

    Real estate is property made up of land as well as anything on ...
Related Articles
  1. Investing

    Use Real Estate To Put Off Tax Bills

    Find out how you can build wealth and reduce your taxes.
  2. Taxes

    How Does a Tax-Free Exchange Work?

    In regards to the sale of property, particularly in real estate, a 1031 exchange is increasingly being recognized for its tax benefits to investors of all levels.
  3. Taxes

    10 Things to Know About 1031 Exchanges

    Real estate swaps grow popular, but traps are many. Here's 10 things to know when considering 1031 swaps. Also: Beware new rules on vacation homes.
  4. Tech

    How the New Tax Law Impacts Cryptocurrencies

    The federal tax code changes of 2017 have big implications for crypto investors, traders, issuers and miners.
  5. Investing

    Real Estate Vs. Stocks: Which One's Right For You?

    There are ups and downs for both real estate and stock investments, so before diving in, know the differences between the two.
  6. Investing

    The 10 Habits of Highly Effective Real Estate Investors

    All successful real estate investors share these personal and professional traits, while following these business practices.
  7. Investing

    The Risks Of Real Estate Sector Funds

    Discover the risks and rewards of investing in real estate funds, as well as some of the best and worst performers.
  8. Investing

    A Guide to Real Estate Investing

    Investing in real estate is a popular choice for good reasons, but it's more complicated than owning your typical stocks and bonds.
  9. Investing

    Key Reasons To Invest In Real Estate

    There has been a lot of negativity over the real estate sector since 2008. Here are the reasons why you should be investing in it.
  10. Retirement

    Is Real Estate Your Retirement's Secret Weapon?

    With stocks maybe peaking and fixed-income investments paying less and less, real estate could be the growth opportunity for your retirement portfolio.
RELATED FAQS
  1. Why can real estate be a good addition to a traditional stock and bond portfolio?

    Discover why real estate can be a good addition to a traditional stock and bond portfolio. Real estate is affected by economic ... Read Answer >>
  2. What are the differences between investing in real estate and stocks?

    Invest in real estate by purchasing physical property or buildings, or invest in stocks by buying a claim to a company and ... Read Answer >>
  3. The Role of an Asset Manager in the Real Estate Market

    Find out what role asset managers play in the real estate markets. Learn how real estate portfolios are selected and why ... Read Answer >>
Hot Definitions
  1. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  2. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  3. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  4. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  5. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  6. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
Trading Center