U.S. Taxpayers - Take advantage of the benefits of section 1031 on your foreign property
11 May 2010
Savvy taxpayers have long used the benefits of IRC Section 1031 to defer capital gains taxes by exchanging real estate located in the United States for other real estate in the United States, even if it is located in another state. Also, property located in the U. S. Virgin Islands, Guam and the Northern Mariana Islands may qualify in the exchange of domestic properties. The fundamental requirement of Section 1031 is that the properties involved in the exchange must be held for investment or in connection with a trade or business.
U. S. taxpayers who own foreign property can also benefit from the tax deferral advantages of Section 1031. All foreign property is considered like kind to other foreign property. For example, a U. S. taxpayer who owns property in the Bahamas may exchange it for property located in Bermuda. Similar to exchanges of domestic real property, the same requirement that the properties must be held for productive use in a trade or business or for investments applies. Also, the properties do not need to be similar use so you can exchange an apartment building for a rental single family residence or an office condominium.
The tax deferral benefits of Section 1031 also apply to personal property exchanges. Airplanes, boats, artwork, livestock, heavy equipment, sports teams, and intangible property such as copyrights and patents, may also be exchanged. However, the "like-kind" and "like-class" requirements for personal property are much more strict than they are for real estate. Personal property is like-class if they are in either the same General Asset Class or the same Product Class. There are 13 General Asset Classes. If properties are not in the same General Asset Class, they may qualify as like-class under the same Product Class. Product Classes consist of depreciable tangible personal property as listed in the North American Industry Classification System.
Often, personal property exchanges involve property that is used or held domestically. The benefits of Section 1031 also apply to personal property that is used or held internationally by U. S. taxpayers. To determine if personal property is considered domestic or foreign, one must look to the predominant location and use of the property for a two-year period of time prior to the sale of relinquished property and for two years prior to acquisition of replacement property. For example, a U. S. company may operate one of its airplanes, or a fleet, internationally.
U. S. taxpayers who own foreign property agree that the international component adds much more adventure and complexity to every transaction. Potential language barriers and variations in currency are obvious challenges. Also, the laws and practices of foreign countries are often much different than those in the United States. This will make it more difficult for you to determine if you are receiving free and clear ownership of a property. Perhaps only leasehold estates are granted rather than fee simple title. Some countries prohibit ownership of property by a non citizen. Title insurance can be obtained to insure title and alleviate many concerns; however, the coverage and the form of the policies are different than in the United States.
The bottom line is that a 1031 exchange allows U. S. taxpayers, in an exchange of foreign real property or personal property, to re-invest sale proceeds in replacement properties rather than paying capital gains taxes. This will enable you to accumulate more assets and more wealth! However, you must be prepared for the challenges that may be presented by dealing with foreign properties. As always, we urge you to consult with your legal and tax advisors.