1031 Exchange When You Sell Texas Land: How It Works
Short answer: A 1031 like-kind exchange lets you put off recognizing the gain when you exchange real property held for business or investment for other business or investment real property. Since January 1, 2018 it applies only to real property, and the IRS says improved and unimproved real property are generally like-kind, so land can be exchanged for a building or other land in the United States. In a deferred exchange you must identify the replacement property in writing within 45 days of transferring your land and receive it within 180 days (or by your return's due date, if earlier). A qualified intermediary usually holds the money; cash or other property you receive is taxable. Land held primarily for sale does not qualify. Set it up with a CPA before you close.
If you sell investment land in Texas at a gain, you normally owe federal capital gains tax that year. A 1031 exchange is the main way to put that tax off: you sell the land and buy other investment real estate under a strict set of IRS rules, and the gain is carried into the new property instead of taxed now. This guide explains how it works for land, the two deadlines that trip people up, and what has to be set up before you close.
What a 1031 exchange is
The IRS describes it this way: when you exchange real property used for business or held as an investment solely for other business or investment property, you are not required to recognize a gain or loss under Internal Revenue Code Section 1031. "Not recognize" means the tax is put off, not erased. The gain carries into the property you receive.
Three points from the IRS matter most for land owners:
- Real property only. Since January 1, 2018, Section 1031 applies only to exchanges of real property, not equipment, vehicles or other personal property.
- Land counts. The IRS says real properties are generally of like kind whether they are improved or unimproved. So investment land can be exchanged for other land, or for a rental building, in the United States. Real property in the United States is not like kind to property outside it.
- Not for property held for sale. An exchange of real property held primarily for sale does not qualify. Land you bought to flip, or lots you are developing and selling, are a question for your CPA.
If the land was inherited, ask your CPA first: inherited land often has a stepped-up basis and little gain to defer; see our guide on taxes when you sell inherited Texas land before you go to the trouble.
The two deadlines
Most land exchanges are deferred exchanges: you sell your land first and buy the replacement later. The IRS instructions for Form 8824 set two clocks, both starting when you transfer your land:
- 45 days to identify. The replacement property must be identified within 45 days after the property you give up is transferred. The identification has to be in writing and describe the property clearly.
- 180 days to close. The replacement property must be received within 180 days, or by the due date of your tax return including extensions, whichever is earlier.
The second clock is the one people miss near year-end. If you sell in the fall, the due date of that year's return can come before the 180th day unless you file an extension. Ask your CPA to put both dates on a calendar the day you sign the sale contract.
The qualified intermediary
In a deferred exchange the sale money usually goes to a qualified intermediary, not to you. The Form 8824 instructions say your rights to receive, pledge, borrow or otherwise get the benefit of that money must be expressly limited. They also warn that if the intermediary causes you to miss the timing rules, the transaction will not qualify and the gain may be taxable in the year you transferred the property.
The practical lesson: the intermediary has to be chosen and the exchange documents signed before your land sale closes. Tell the title company and the buyer early that the sale is part of an exchange.
Cash you take out is taxable
An exchange does not have to be all or nothing, but anything other than like-kind property has a cost. The IRS says you must recognize a gain to the extent of other property and money you receive. If you sell land for $200,000 and buy replacement property for $150,000, keeping the difference in cash, expect tax on that part of the gain. You also cannot recognize a loss in a like-kind exchange.
The exchange is reported on Form 8824, Like-Kind Exchanges. Related-party exchanges have extra rules, including a two-year holding rule, so mention any family or business connection to your CPA.
How it compares with simply paying the tax
An exchange is worth the effort when the gain is large and you want to stay invested in real estate. It is often not worth it when:
- the gain is small, or the basis was stepped up at inheritance;
- you want the cash for something other than real estate;
- you are not sure you can find and close on replacement property in the time allowed.
Our guide on capital gains tax when you sell Texas land shows how to estimate the tax you would pay without an exchange, so you can compare the two. If you are weighing seller financing instead, which spreads the gain over time rather than deferring it, see installment sale taxes when you owner-finance Texas land.
Selling to us as part of an exchange
A cash buyer can be the buyer of your relinquished land in an exchange, as long as your intermediary and documents are in place before closing. If that is your plan, tell us when you ask for an offer, and tell your CPA and intermediary about our offer before you sign. If you are looking for replacement land, you can also browse the Texas land we have for sale.
Ready for a number to plan around? You can ask us for a cash offer. It comes in writing, with no obligation.
Common questions
- Can I do a 1031 exchange with vacant land in Texas?
- Yes, if the land is held for business or investment. The IRS says real properties are generally like-kind whether they are improved or unimproved, so investment land can be exchanged for other investment real property in the United States, such as other land or a rental building. Land held primarily for sale does not qualify.
- What are the 1031 exchange deadlines?
- The Form 8824 instructions say the replacement property must be identified within 45 days after you transfer the property you give up, and received within 180 days, or by the due date of your tax return including extensions, whichever is earlier. Missing either deadline can make the gain taxable.
- Do I need a qualified intermediary?
- In a typical deferred exchange, yes. The intermediary holds the sale money so you do not have the use of it, and your rights to the money must be expressly limited. The IRS warns that if the intermediary causes you to miss the timing rules, the transaction may not qualify and the gain may be taxable.
- Is any part of a 1031 exchange taxable?
- The IRS says you must recognize gain to the extent of other property and money you receive in the exchange. So if you take some cash out, that part can be taxed. Losses cannot be recognized in a like-kind exchange.
- Can I exchange Texas land for my home?
- The exchange has to be for other property held for business or investment. A home you plan to live in is not investment property. Ask a CPA before you count on an exchange.
Sources
- IRS: Like-Kind Exchanges, Real Estate Tax Tips
- IRS: Instructions for Form 8824, Like-Kind Exchanges
- IRS Tax Topic 409: Capital gains and losses
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