Any property that is held for productive use in a trade or business or for an investment purpose such as rental homes, duplexes, land, apartments, office buildings, shopping centers, or warehouses are eligible for a 1031 tax deferred exchange.

A 1031 exchange is a very advantageous tax deferral strategy. Anyone involved with advising real estate investors should know about this tax-deferred exchange. Taxpayers should never pay income taxes on the sale of property if they intend to reinvest the proceeds in similar or like-kind property.

The primary advantage of a 1031 exchange is the ability of a taxpayer to sell income-producing property and replace it with similar replacement property without having to pay federal income taxes on the transaction. Simply selling a property and replacing it with another property doesn't work, there has to be a formal exchange.

IRC Section 1031 is the mechanism for tax-deferred exchanges. The relinquished (sold) property must be a qualifying property. To be a qualifying property the property must be held for investment purposes or used in a taxpayer's trade or business. Such properties can include real estate either held for investment or held as an income producing property.

Property that would not qualify for a 1031 exchange includes a personal residence, construction or 'flips' purchased for resale, inventory, stocks or bonds or other partnership (including LLC) interest.

The replacement property must be of a like kind. This means that in real estate exchanges both the relinquished and the replacement property must be real estate; however, improved real estate can be replaced with unimproved real estate and unimproved real estate can be replaced with improved real estate. Also a 100% interest in one property can be exchanged for a percentage interest in a property with multiple owners.

Another important factor in determining if the property qualifies for a 1031 exchange is the taxpayer's ability to demonstrate 'intent' For example, a replacement property does not have to be rented for it to qualify as a 1031 replacement property, but it does have to be 'held for investment purposes.' This simply means that the taxpayer has to be able to demonstrate this intent. Renting the property makes it easier for the taxpayer to demonstrate this intent and the property can be rented to anyone, including family members as long as they are paying a fair rent. However, if there is a period of time after the exchange that the property is not rented, the 'intent' may still be valid. This 'intent' applies to all replacement properties acquired in a 1031 exchange whether they're subsequently rented out or not.

There are four basic types of 1031 exchanges.

1. A simultaneous exchange is an exchange in which the closing of the relinquished property and the replacement property occur on the same day.
2. A delayed exchange is an exchange where the replacement property is closed on at a later date than the closing of the relinquished property. There are strict time frames established by the IRS for completion of a delayed exchange. In particular you must have the replacement property identified within 45 days and be closed on the replacement property within 180 days.
3. A reverse exchange, also known as a title-holding exchange, is one in which the replacement property is purchased and closed on before the relinquished property is ever sold. In such a case an intermediary normally takes title to the replacement property and holds the title until the taxpayer can sell the relinquished property.
4. An improvement exchange is when the taxpayer desires to acquire the replacement property and arrange for construction or improvements on the property before it is officially received as the replacement property. IRC Section 1031 does not permit a taxpayer to construct improvements on a property as part of a 1031 exchange after he has taken title to property as replacement property in an exchange. It is required that the intermediary close on and hold title to the property until the improvements are constructed and then transfer the title to the improved property to the taxpayer as replacement property.