Take Care When Making 1031 Exchanges Outside of the U.S.

By Emma J. Connly

Section 1031 gives real estate investors a wonderful gift in the form of a tax deferral, a kind of 'interest-free loan' from Uncle Sam. This may give you cause to wonder why the government would see fit to do this. As a matter of fact, section 1031 is not a naked gesture of goodwill, but a calculated, mutually beneficial arrangement. Giving investors the ability to place their assets in the best investments possible stimulates the U.S. economy, creating new jobs and new opportunities for Americans.

By this logic, it wouldn't make sense to allow 1031 exchanges to be made on properties overseas, and this is indeed prohibited. Section 1031 is at least partially intended to encourage investors to invest in property located in the U.S., both for the sake of the economy and because it can be difficult or impossible for taxes to be collected on foreign property (remember that a tax deferral is more of a loan than a gift, and the IRS expects to collect on this loan in the event that you sell a replacement property outright).

But what if you would like to make an exchange on a property located in Guam, Puerto Rico, or another U.S. territory? According to a precedent set by a private letter ruling relating to an exchange on a property located in the U.S. Virgin Islands, this is allowed, but the like-kind requirements on an exchange of this sort are more stringent than those that apply normally, in that a property located in a U.S. territory must be income-producing in order to qualify as like kind with one located in the United States proper.

The path of least resistance when it comes to making a 1031 exchange is to confine your transactions to the United States, which comprise the fifty states as well as Washington D.C. In the event that you find it necessary to make an exchange on property located in an outside territory, I advise you to carefully analyze your replacement property to make sure it meets like-kind requirements. You may even want to request your own private letter ruling from the IRS.

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United States investors can save a lot of 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!

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