Taxpayers seeking to maximize their wealth and expand their real estate portfolios often turn to a powerful financial tool: the 1031 exchange. What property is eligible for a 1031 exchange? What are the benefits? What’s new in 2024? We explore here.

What is a 1031 or like-kind exchange?

Section 1031 of the Internal Revenue Code (IRC) allows you to defer gains on real property used in a business or held for investment if, rather than selling it, you exchange it solely for property of a like-kind.

In the past, the IRS was fairly flexible on what property could be exchanged under this break. For example, you could swap an apartment building for a strip mall.

Or you could swap one business or investment property for multiple replacement properties.

The TCJA eliminated 1031 exchange eligibility for personal property, limiting it to solely real property. Under regulations released in late 2020, the IRS clarified the definition of real property.

What is real property?

For purposes of section 1031, real property is considered as such if it is:

• Specifically listed as real property in the final regulations

• Classified as real property under the state and local law test included in the final regulations

• Considered real property based on all the facts and circumstances under the various factors provided in the final regulations.

What are the benefits of 1031 exchanges?

• Capital gain deferral: In most cases, 1031 exchanges defer capital gains tax until you sell the replacement property. But, you may be able to eliminate the capital gains tax bill — if you retain the replacement property for life. Then, your heirs will receive a stepped-up basis in the property, which erases any capital gains tax accumulated over your lifetime.
• Estate Planning Advantages: Heirs can benefit from a stepped-up basis, potentially eliminating deferred gains.
• Enhanced Investment Potential: Reinvesting pre-tax dollars boosts purchasing power for new investments.
• Portfolio Diversification: Offers the chance to diversify by swapping one property type for another.
• Depreciation Reset: Provides an opportunity to reset the depreciation schedule on a new property.
• Consolidation or Expansion: Facilitates the consolidation of multiple properties into one or the expansion into several properties.
• Improved Cash Flow: Potential to exchange for properties with better cash flow or growth prospects.

Additionally, if you combine a 1031 exchange with a cost segregation study, you increase your benefits. Read more about cost seg studies in our blog, Take Advantage of a Cost Seg Study Before Bonus Depreciation Phases Out.