1031 Tax Exchange Information

Section 1031 of U.S. tax code is based on the idea of a mutually beneficial relationship between the real estate investor and the U.S. economy as a whole.  1031 exchanges allow investors to put their capital to work in the most advantageous ways possible, which in turn stimulates the economy by creating more jobs and greater opportunity in the U.S.  This is one major reason why 1031 exchanges cannot occur outside of U.S. territory.  In addition, a tax deferment means that the IRS will want to collect your capital gains taxes in the event that you someday sell your replacement property, and it can be very difficult for them to collect taxes on the sale of foreign property.

The fact that 1031 exchanges are intended to boost the U.S. economy raises the question of whether one can exchange a property for one located overseas.  The short answer is no.  The money you save by making a 1031 exchange rather than selling outright is considered a tax deferment, which means that although you are temporarily liberated from capital gains taxes, the U.S. government will still want to collect the money if you sell your property at some point in the future.  It is difficult and sometimes impossible for the IRS to collect taxes on the sale of foreign property.

If 1031 exchanges are limited to the U.S. so that the economy will benefit and the IRS will be able to collect capital gains taxes in the future, then you may be wondering what rules apply to U.S. territories such as Guam, the U.S. Virgin Islands, and Puerto Rico.  In private letter rulings, the IRS has stated that a Virgin Islands property can only qualify as like-kind in an exchange with a U.S. property if it is income-producing, which is more restrictive than the normal requirements for a like-kind exchange, which merely state that the property must be held for your trade or business or as an investment.

So if you are considering making an exchange outside of the fifty states (and Washington D.C.), make certain that your replacement property will, in fact, be considered to be like-kind to the property that you are selling.  In order to be absolutely sure, you may even want to request a private letter ruling on your particular case.

United States investors can save their money by using a 1031 exchange to defer all of their capital gains tax on the sale of investment property. A 1031 tax exchange is almost like getting an interest free loan from Uncle Sam!