Can a Corporation Do a 1031 Exchange?

A 1031 exchange, often called a like-kind exchange, permits investors to defer capital gains taxes when trading one investment property for another. This tax deferral allows property owners to reinvest proceeds that would otherwise be paid as taxes, facilitating continued growth of their investment portfolio. Originating from Section 1031 of the Internal Revenue Code, the core concept is the swap of real estate held for business or investment purposes for other like-kind real estate. While commonly associated with individual investors, corporations can generally utilize 1031 exchanges, though their use involves specific considerations.

Corporate Eligibility for 1031 Exchanges

Different corporate structures have varying implications for 1031 exchange eligibility. C corporations are eligible for 1031 exchanges because they operate as distinct tax-paying entities capable of holding property for business or investment purposes. The corporation itself, as the legal owner, conducts the exchange.

S corporations can also engage in 1031 exchanges. The exchange process occurs at the corporate level, meaning the S corporation is the party exchanging the property. While S corporations are pass-through entities, the tax deferral from a 1031 exchange initially applies at the corporate level. This deferral can indirectly influence a shareholder’s stock basis after the exchange.

Limited Liability Companies (LLCs) that elect to be taxed as C or S corporations must follow the same 1031 eligibility rules. For any corporate entity, the property being exchanged must meet the “held for productive use in a trade or business or for investment” requirement of Section 1031. This means the property cannot be inventory held primarily for sale, nor can it be personal-use property. The intent behind holding the property is for investment or business operations.

Applying 1031 Exchange Rules to Corporations

When a corporation undertakes a 1031 exchange, it must adhere to the fundamental rules governing these transactions. The “like-kind” requirement, defined in Section 1031, mandates that exchanged properties must be of the same nature or character. For real property held by a corporation, this means any real estate held for investment can be exchanged for any other real estate held for investment, such as an apartment building for raw land or a commercial office for agricultural land.

A Qualified Intermediary (QI) plays a key role in facilitating a deferred exchange for a corporation. The QI, a neutral third party, holds the proceeds from the sale of the relinquished property, preventing the corporation from having constructive receipt of the funds. This is essential for maintaining the tax-deferred status, as direct receipt of funds would trigger immediate taxation. The QI then uses these funds to acquire the replacement property on behalf of the corporation.

Specific timelines govern 1031 exchanges, applying equally to corporations. The corporation has 45 calendar days from the sale of the relinquished property to identify potential replacement properties. This identification must be in writing and describe the properties, such as by legal description or street address. The corporation then has 180 calendar days from the sale of the relinquished property to close on the replacement property.

Any non-like-kind property or cash received in an exchange is known as “boot” and can trigger taxable gain for the corporation. Examples of boot include cash received directly, debt relief not replaced with new debt, or personal property received in a real estate exchange. The amount of boot received is taxable up to the amount of realized gain. The deferred gain reduces the tax basis of the newly acquired replacement property, ensuring it is recognized when the replacement property is sold in a future taxable transaction.

Unique Corporate Considerations in a 1031 Exchange

Corporations engaging in a 1031 exchange encounter specific complexities beyond the general rules. Depreciation recapture, which occurs upon the sale of depreciated property, is deferred at the corporate level in a 1031 exchange. This deferral applies to both capital gain and depreciation recapture, postponing their recognition until a future taxable disposition of the replacement property.

For S corporations, the deferred gain from a 1031 exchange affects the corporation’s accumulated adjustments account (AAA). This impact on the AAA influences the tax attributes flowing through to its shareholders.

An important consideration arises if the corporation holding the replacement property is later dissolved or liquidated. A corporate liquidation triggers the deferred gain at the corporate level under Section 336, as if the property were sold at fair market value. Additionally, shareholders often recognize gain or loss under Section 331, treating amounts received as payment for their stock. This dual taxation can negate the benefit of the 1031 exchange if not carefully planned.

State tax laws concerning 1031 exchanges can vary, and corporations must consider potential state-specific corporate-level taxes or reporting requirements. Some states may have different rules for recognizing deferred gains or impose their own taxes. An S corporation that previously operated as a C corporation may also face a built-in gains (BIG) tax under Section 1374. This tax applies if assets that appreciated while the entity was a C corporation are sold within a recognition period, even if the sale is part of a 1031 exchange.

The “held for productive use” rule is important for corporate property that might be perceived as having personal use by shareholders. If a property is deemed for a shareholder’s personal enjoyment rather than for the corporation’s business or investment purposes, the exchange could be disqualified.