What is the definition of a 1031 Exchange?

Named after IRS section 1031, a 1031 exchange allows the landowner to avoid capital gains tax when selling real property and then purchasing a like-kind property. So long as the value of the replacement land is greater than or equal to the original land sale and you never receive any proceeds, the 1031 exchange receives tax-deferral. IRS safe harbor rules also dictate that the taxpayer must relinquish the rights of both parcels during the process to a qualified intermediary (QI). 

How Long Do You Have to Exchange Land?

You must identify a replacement for the land you sold within 45 days. This window is referred to as the “identification period.” Your potential replacement land options must be delivered to all interested parties surrounding the transaction. You then typically have 180 days to acquire and purchase a new replacement parcel. This last phase is often called the “exchange period.”

What Types of Property Qualify for a 1031 Exchange?

The good news is that land and ranches are always able to be exchanged using IRS section 1031. Other common types of real property exchanged are:

  • Multi-Family Housing Units  
  • Retail Outlets
  • Office Buildings
  • Factories & Industrial Complexes
  • Storage Facilities

Additional real property specifically involved in farm and ranch 1031 exchanges are:

  • Oil & Gas Investments
  • Farm & Ranch Machinery
  • Livestock
  • Feed Lots, Livestock Sale Barns, Granaries 

You cannot exchange or replace personal property like vehicles and artwork. Also, the IRS does not normally allow you to execute a 1031 exchange involving your primary residence unless it is part of, or converted into, a multi-family apartment unit. 

Other rules dictate you must operate the replacement property as its intended business purpose. For example, acquired farmland should continue to be planted and not converted into a lake. You should also keep the same ownership titles throughout your exchange or risk having the exchange rejected.  

What Happens if My Replacement Land is Cheaper Than the Original?

The overall goal of a 1031 exchange is to purchase replacement land or ranch that is of a similar or higher value to your current parcel. That being said, many factors can come into play like market swings and interest rates pushing the future sale lower than the original. If the replacement land or ranch is not equal or greater than the first, the difference is called a “boot.” 

  • A cash boot occurs when the purchase price of the replacement land is less than the original. Example: if you sell land worth $500,000 without a mortgage and then pay cash for land worth $450,000.
  • A debt reduction boot happens when a parcel is financed for less than the original mortgage. Example: If you sell a ranch for $400,000 with a $250,000 mortgage and buy another ranch for $350,000 with a $200,000 mortgage.  

Any capital gains realized from the boot will be taxed. While this scenario is no longer tax-free, please keep in mind, a 1031 exchange can absolutely still be executed. Sometimes, your situation calls for some up-front liquidity making a partial 1031 exchange advantageous. 

Are you considering a 1031 exchange? Campbell Farm & Ranch is a team of local Texas experts. We will guide you through the process ensuring your 1031 sale and replacement maximizes your returns. Please don’t hesitate to give us a call today and discuss your unique circumstances.  

 

Boone Campbell, Broker

(940) 549-7700  |  Boone@cfrland.com