A section 1031 exchange (also referred to as a "like-kind exchange") permits the owner of property to exchange such property for property of a like-kind without recognizing any United States Federal income tax on any gain derived from the disposition of the owner's current property. Thus, any taxpayer, including any foreign investor subject to United States income taxes is able to utilize Section 1031 to exclude such gain from their U.S. Federal taxable income. There are a significant number of rules that must be strictly followed in order for an exchange to qualify for non-recognition treatment under Section 1031. For real property, what is like kind is relatively broad. BOTH the current property and the new property must be EITHER (i) investment property or (ii) real property used in a trade or business. Investment real property can be exchanged for real property used in a trade or business and real property used in a trade or business can be exchanged for investment real property. Neither property, however, can be personal use property or inventory/property held primarily for sale to customers. Significantly, however, real property located in the United State IS NOT like-kind property as to property located outside the United States. Thus, U.S. real property must be exchanged for other U.S. real property and foreign real property must be exchanged for other foreign real property. Rarely is a like-kind exchange achieved by a simultaneous exchange (swapping property directly for another property or all transfers completed on the same day). Instead, like-kind exchanges are generally accomplished by way of a deferred exchange, where the current property is sold and then the replacement property is subsequently purchased with 180 days (Less common is the reverse exchange, where the new property is acquired before the old property is sold). There are a number of additional rules that must be strictly followed in order to achieve a deferred 1031 like kind exchange, most importantly is a use of a Qualified Intermediary to hold the proceeds from the sale of the current property. Assuming FIRPTA withholding would otherwise be required, a Section 1031 exchange will generally require withholding unless either (i) the exchange is quickly completed or (ii) a withholding certificate from the IRS is obtained. The exception for exchanges that are completed quickly creates an exemption from FIRPTA withholding ONLY if (i) the 1031 exchange is a simultaneous exchange or is completed within 20 days of the transfer (the due date of Form 8288) AND (ii) the transferor certifies in writing to the transferee that the exchange entirely qualifies for non-recognition treatment. If the previous exemption doesn’t apply, then a withholding certificate from the IRS must be received in order to be exempt from withholding and transferring the withheld funds to the IRS. Either the transferee or transferor my apply for the certificate by filing Form 8288-B. The IRS generally responds within 90 days after application is received. If a withholding certificate application has been filed and the sale occurs, the transferee doesn’t have to file the Form 8288 and transfer the withheld amounts until notice has been received from the IRS either granting or denying the certificate (amounts should still be withheld, they don’t need to be transferred to the IRS until a response is received).
