In the continued quest to debunk all myths around the 1031, next up is one of the more common myths of the Tax Deferred 1031 Exchange is that vacant land doesn’t qualify for a 1031 Exchange. This misunderstanding can lead investors to miss out on valuable tax deferral opportunities and limit their ability to strategically manage their portfolios. The truth is, vacant land is a perfectly valid property type for a 1031 Exchange, provided it meets the basic criteria set forth by the Internal Revenue Code (IRC) Section 1031.
The Basics of 1031 Exchanges
A 1031 Exchange allows real estate investors to defer paying capital gains taxes when they sell one investment property and reinvest the proceeds into another like-kind property. The term “like-kind” is often misunderstood, which can lead to the myth about vacant land. Under IRS regulations, “like-kind” doesn’t refer to the specific use of a property (e.g., a rental property for another rental property, although this does qualify) but rather the general nature or character of the real estate involved. As long as both the relinquished and replacement properties are held for investment, trade or business purposes, they qualify for a 1031 Exchange.
Vacant Land Qualifies as Investment Property
One of the main rules of a 1031 Exchange is that the property involved must be “held for productive use in a trade or business or for investment purposes.” Vacant land, despite being undeveloped, is frequently held for investment purposes. Whether it’s purchased with the intention to appreciate over time or to be developed for commercial or residential purposes in the future, vacant land can easily qualify as an investment property. The IRS does not require that the property be improved or generating income to be considered eligible.
In fact, many real estate investors purchase vacant land with the intent to hold it as an appreciating asset. Sometimes this land is located in areas with expected future growth, or it may have strategic value for future development. As long as the investor’s intention is to hold the land for investment purposes rather than personal use, it qualifies for a 1031 Exchange.
Misunderstanding the “Like-Kind” Rule
The confusion about vacant land often arises from a misunderstanding of the “like-kind” requirement. Some investors mistakenly believe that because vacant land doesn’t have structures on it, it is fundamentally different from other types of real estate. However, the IRS has a broad interpretation of “like-kind” in the context of real estate.
For instance, an investor can sell a commercial building and use the proceeds to buy vacant land, or vice versa, and still qualify for a 1031 Exchange. Similarly, an investor can exchange farmland, a warehouse, or even a shopping center for vacant land without breaking the like-kind rules. The IRS looks at all investment or business real estate as like-kind to other investment real estate, as long as it is held for investment, trade or business purposes. Therefore, vacant land is treated the same as developed real estate in the eyes of the tax code.
Common Scenarios Where Vacant Land is Used in a 1031 Exchange
Many real estate investors use 1031 Exchanges to defer taxes when they sell vacant land, particularly in cases where they have held the land for long-term investment purposes. For example:
- Land Banking: Investors often purchase vacant land in areas with projected growth and hold onto it until the market conditions are favorable for a sale. The appreciated value of the land makes it a prime candidate for a 1031 Exchange, allowing the investor to sell the land and defer taxes while reinvesting in another income-producing property.
- Development Opportunities: In other instances, investors may purchase vacant land with the intention of developing it later. If plans change, and they decide not to develop, they can sell the land and use a 1031 Exchange to purchase another investment property.
- Agricultural Uses: Farmland, including vacant land intended for farming or ranching, also qualifies for 1031 Exchange treatment. Even if the land is not actively farmed at the time of the sale, it can still be considered investment property.
The myth that vacant land doesn’t qualify for a 1031 Exchange is simply that—a myth. Vacant land can be a valuable part of any real estate investor’s portfolio and, when held for investment purposes, fully qualifies for tax deferral under IRC Section 1031. The flexibility of 1031 Exchanges allows investors to leverage their investments, swap out non-income producing land for more lucrative properties, or diversify their holdings—all while deferring capital gains taxes.
As with any tax-deferral strategy, it’s important for investors to work with knowledgeable professionals, such as qualified intermediaries and tax advisors, to ensure they’re adhering to IRS guidelines. By understanding the full range of properties that qualify for a 1031 Exchange, including vacant land, investors can maximize the benefits of this powerful wealth-building tool.
If you are an investment property owner who is interested in a no obligation, private consultation, please visit www.Best1031Online.com, or contact James Bean
of SVN-Rich Investment Real Estate Partners, CA DRE# 01970580, at 805-779-1031
or email at [email protected].
If you are an agent/broker, I am happy to discuss strategies with you on how to best serve your next listing client in preparing them for a successful exchange. Please visit the site and click on the Agent’s button located at the top right-hand corner of the Home Page!
Don’t know what certain terms mean?
Click here for a Glossary of Terms: https://svn-best1031online.com/glossary/
Want more on the 1031 Exchange?
Come join me on my YouTube Channel “Best 1031 Online”
The only channel dedicated to all things 1031!
And please stay tuned and follow me on LinkedIn, X (formerly known as Twitter), Instagram, YouTube & Facebook @1031BrokerJames.
All information is deemed to be accurate, and not advice. All investors/taxpayers should consult their CPA, tax attorney and investment advisors.