Most of the people want to use tax deferred methods in order to avoid paying taxes, 1031 Exchange is thus one of the most talked about and popular ways by which exchange of real estate and property is possible without paying taxes. The 1031 Exchange is based on simple rule that any exchange to be done should be qualified as to be exchanged in the law.
For any person looking for an exchange of property then the Relinquished Property must be qualifying property to be qualified for this. The property that can be Qualified include property (or equipment) held for investment purposes or used in a taxpayer's trade or business. It doesn’t involve any personal property or any property (or equipment) including Land under development for resale, Construction or fix/flips for resale, Property purchased for resale, Inventory property, Corporation common stock, Bonds, Notes and Partnership interests and hence deals with a very selective property qualifying as the 1031 Exchange.
When the Exchange 1031 talks about the Investment property it includes all sorts of real estate, improved or unimproved that have been held for the investment or income producing purposes as part of the business or any side income. Similarly when we talk about the trade and business property then it includes al the offices or place of doing business, as well as equipment used in his trade or business. But all these real estate and property have to be replaced with like-kind real estate. Equipment must be replaced with like-kind equipment.
Because of all these restrictions and rules, 1031 Exchange has a lot of value for anyone who is looking for deferral strategies to avoid paying tax against the exchange of property and other stuff. Most of the people worry about paying income taxes when they sell or buy a property but with the helps of 1031 tax exchange they never have to pay income taxes on the sale of property if they intend to reinvest the proceeds in similar or like-kind property.
The exchange 1031 also involves much more rules when we talk about the real estate in general, e.g. the ownership title remains unchanged even after the exchange, i.e., if two persons are owning the property or real estate jointly then the exchanged property will be the ownership of both not held singly. Similarly it goes with the organizations and corporate as the ownership will remain with the same name as the property/real estate has been changed.
If there is any monetary gain or the Boot in the exchange then that Boot is taxable. Most of the time, people use the boot in order to pay the debt, their taxes and much more stuff like that. But keeping in view the terms & conditions, the boot can be avoided completely and the transaction can be done completely tax-free. Most of the lawyers and people dealing with the Exchange 1031 tell a basic rule of thumb regarding boot and that is when you sell your property, the replacement property must equal or be greater than the value and existing debt of the property being sold, and all of your equity from the property you are selling must go into acquiring the replacement property. They advice never to "trade down" as it results in boot received, either cash, debt reduction or both.