Can You Do a 1031 Exchange With Stocks?
Understand the tax code's distinction between real property and financial assets, which is why 1031 exchanges are limited to specific types of investments.
Investors cannot use a 1031 exchange to defer capital gains taxes on appreciated stocks. This tax strategy is designed for certain types of property, and financial instruments like stocks and securities are explicitly excluded. The rules governing these exchanges are precise, limiting their application to a narrow category of assets.
Defining a Section 1031 Exchange
A Section 1031 exchange allows an investor to postpone paying capital gains tax on the sale of a property by reinvesting the proceeds into a new, similar property. The core principle of this provision is the concept of a “like-kind” exchange, meaning the relinquished property must be swapped for a replacement property of a similar nature. Both properties must be held for productive use in a trade or business or for investment.
This tax deferral does not eliminate the tax liability but postpones it. The original cost basis from the relinquished property is carried over to the replacement property, meaning the deferred gain is recognized when the new property is sold for cash. An investor must identify a potential replacement property within 45 days of selling their original property and complete the acquisition within 180 days. All proceeds from the initial sale must be used to purchase the new property for full tax deferral.
The Exclusion of Stocks and Securities
The Internal Revenue Code prohibits using a 1031 exchange for stocks, bonds, notes, and other securities. Corporate stocks and partnership interests have never been eligible for this tax treatment. The reason for this is that these financial instruments are not considered “like-kind” to the real assets for which the exchange was designed.
The Tax Cuts and Jobs Act of 2017 (TCJA) narrowed the scope of 1031 exchanges. Effective January 1, 2018, the provision was limited to apply only to exchanges of real property. Before the TCJA, certain types of personal property, such as machinery, vehicles, and artwork, could qualify for a like-kind exchange, but that is no longer the case.
A common point of confusion arises with Real Estate Investment Trusts (REITs). While REITs invest in real estate, they are traded on stock exchanges like any other corporate stock. Because they are classified as securities, REIT shares cannot be used in a 1031 exchange to acquire a property, nor can a property be exchanged for REIT shares.
Qualifying Property Post-TCJA
Following the TCJA, only real property held for business or investment purposes is eligible for a 1031 exchange. The IRS defines real property as land and anything permanently built on or attached to it.
Examples of qualifying real property include rental homes, apartment buildings, commercial storefronts, office buildings, and even undeveloped land. The properties, both the one being sold and the one being acquired, must be of a similar nature in the context of being real estate. For instance, an investor could exchange an apartment building for a piece of raw land or a commercial office space for a portfolio of single-family rental houses.
Regulations clarify that certain intangible interests connected to real estate, such as leaseholds with 30 years or more remaining, can also qualify. However, property held primarily for sale by a developer does not qualify.