Advisor Quick Screen: Does This Client Qualify for a 1031 Exchange?

How to Use This Quick Screen

You are in a client annual review or a planning meeting. The client mentions she is selling a piece of real estate. Before you spend time on detailed planning or engage a QI, use this framework to ask six key questions.

Spend no more than 5 minutes. If the answer to any question is a red light, flag it and either consult counsel or escalate to the client's CPA before proceeding.

Question 1: Is It Real Property?

The Question: What type of asset is the client selling? Is it real estate, or is it something else (equipment, vehicles, intellectual property, securities)?

Why It Matters: Post-TCJA, only real property qualifies for 1031 treatment. Personal property, equipment, vehicles, and other assets are no longer eligible. If the client is selling anything but land, a building, an operating business real estate asset, or an easement on real property, it does not qualify.

What Counts as Real Property:

• Land (improved or unimproved).
• Residential rental properties (single-family, multifamily, etc.).
• Commercial real estate (office, retail, industrial, warehouses).
• Hospitality properties (hotels, motels, short-term rentals held for investment).
• Agricultural properties (farms, orchards, ranches).
• Operating business real estate (restaurants, gas stations, convenience stores, dental offices).
• Easements and water rights (in some cases).
• Timeshare interests and fractional ownership in real property (in limited cases).

What Does NOT Count:

• Equipment bolted to the floor (e.g., café equipment, dental chairs, manufacturing equipment). Equipment is personal property.
• Vehicles and aircraft.
• Stocks, bonds, mutual funds, ETFs, REITs (these are securities, not real property).
• Cryptocurrency.
• Collectibles and art.
• Business inventory or goodwill.
• Leasehold interests (depending on the lease term and jurisdiction; consult counsel).

Green Light or Red Light?

• Green: Client is selling a rental property, office building, farm, or operating business real estate.
• Yellow: Client is selling an easement or water rights; consult counsel on state law.
• Red: Client is selling equipment, vehicles, securities, or any non-real-estate asset. Do not proceed with 1031 planning. 1031 does not apply.

Question 2: Is It Held for Investment or Productive Use in a Trade or Business?

The Question: What is the client's stated purpose for holding this property? Is it investment property (rental income or appreciation), or is it used in the client's trade or business?

Why It Matters: A 1031 exchange applies only to property held for investment or productive use in a trade or business. Personal-use property (a primary residence, a vacation home used by the owner, a second home for personal stays) does not qualify. The IRS will examine the client's actual use and intent.

Key Distinctions:

Green Light or Red Light?

• Green: The property is a long-term rental, operating business real estate, or vacant land held for investment.
• Yellow: The property is a short-term rental or formerly personal-use property. Consult the client on actual use and document intent.
• Red: The property is a primary residence or vacation home used personally by the owner. Do not proceed. 1031 does not apply.

Question 3: Who Is the Taxpayer? Does the Seller Match the Buyer?

The Question: Who legally owns the property being sold? Is it an individual, an LLC, an S-corp, a partnership, a trust, or another entity?

Why It Matters: This is the "same taxpayer" rule. The entity on the sale side must be identical to the entity on the purchase side. If the property is titled in Jane's name individually, Jane must take title to the replacement in her name. If the property is held in "XYZ Rentals LLC," the replacement must be held in "XYZ Rentals LLC."

This rule prevents the client from using the exchange to restructure ownership or transfer property between entities without tax consequences.

Key Scenarios:

Green Light or Red Light?

• Green: The entity on the sale side is identical to the entity on the purchase side.
• Yellow: The client is considering a restructuring or change of entity. Pause and consult an attorney. Do not proceed until the structure is finalized.
• Red: The sale and purchase are in different names or entities. The "same taxpayer" rule fails. Do not proceed without a formal legal opinion.

Question 4: Is This a Related-Party Transaction?

The Question: Is the buyer of the relinquished property a "related party" to the client, as defined by IRC 1031(f)? Is the client planning to acquire a replacement from a related party?

Why It Matters: The Tax Cuts and Jobs Act added a related-party rule to IRC 1031. If both the relinquished property and the replacement property are acquired from related parties, and the related party disposes of the property within 2 years of the client's acquisition, the client's exchange may be disqualified retroactively and the client will owe tax.

This rule does not eliminate related-party exchanges; it just adds a 2-year "cliff" risk.

Related Parties Include:

• Spouses and lineal descendants (children, grandchildren, etc.).
• Ancestors (parents, grandparents, etc.).
• Siblings and their spouses.
• Corporations in which the client owns 50% or more.
• Partnerships in which the client owns 50% or more.
• Trusts of which the client is a beneficiary.

Red Flag Scenarios:

• The client is selling to a family member and buying from another family member.
• The client is selling to her children and buying from them in return.
• The client is swapping properties with a brother or sister.
• The client is acquiring property from a family partnership or family LLC.

Green Light or Red Light?

• Green: The related-party rule is not applicable (the transaction is arm's length).
• Yellow: There is a related-party on one side (sale or purchase) but not both. The client can proceed but should be aware of the risk if a second transaction involves a related party.
• Red: Both the sale and purchase involve related parties. Consult a tax attorney on the 2-year disposition rule. The client can still do the exchange, but the related party must hold the replacement for 2+ years or the exchange will fail.

Question 5: Is There a Tight Timeline?

The Question: When is the property expected to close? Is there enough time to engage a QI, identify replacement property, and close on the replacement within the 45/180-day window?

Why It Matters: The 1031 timeline is absolute and unforgiving. If the closing is happening next week and no QI is engaged, the client will be scrambling. Procrastination near the deadlines is how exchanges fail.

Timeline Red Flags:

• The property closes in less than 10 days and no QI is engaged.
• The property closes on Day 1, and the client has no replacement property identified.
• The client wants to close on the replacement on Day 178 or Day 179, leaving zero margin for error.
• The client is still negotiating a purchase contract on Day 140 (only 40 days until the deadline).

Green Light or Red Light?

• Green: The closing is 30+ days away, a QI is already engaged, and the client has identified 2-3 candidate properties.
• Yellow: The closing is 10-30 days away, and a QI is not yet engaged. Call immediately and confirm engagement.
• Red: The closing is in less than 10 days, or the closing is imminent, and no QI is engaged. This is an emergency. Contact a QI immediately. Some QIs can move very fast, but there is no margin for error.

Question 6: Are There Disqualifying Red Flags?

The Question: Are there any other facts or circumstances that suggest the property might not qualify?

Why It Matters: Dealer status, recent personal-use history, suspicious timing, and entity restructuring can all trigger IRS scrutiny or disqualify a 1031 exchange.

Key Red Flags:

Green Light or Red Light?

• Green: No red flags. Proceed with confidence.
• Yellow: One or more yellow flags present (recent conversion, tight timeline, related-party sale). Proceed but consult specialists as needed.
• Red: One or more red flags present (likely dealer status, suspicious timing, ongoing entity restructuring). Do not proceed without a formal opinion from a CPA or tax attorney.

The Decision Framework: Green, Yellow, Red

After asking the six questions, assess the overall risk profile using this framework.

GREEN LIGHT: PROCEED WITH CONFIDENCE

The client qualifies for a 1031 exchange. There are no material disqualifying facts. Proceed with planning, engage the QI, and manage the timeline.

Example: Jane owns a 10-unit multifamily apartment building held in "Jane's Rental Properties LLC" for 8 years. She wants to sell it and buy a commercial office building in the same LLC. The sale closes in 60 days. No related parties involved. No dealer status concerns. Proceed.

YELLOW LIGHT: PROCEED WITH CAUTION; CONSULT SPECIALISTS

The client may qualify, but there are one or more yellow-flag facts that require specialist review before proceeding. Do not engage a QI until you have clarity.

Examples:

• The property is a short-term rental (is it held for investment or is it personal use?). Consult the CPA on the client's intent and actual use.
• The client wants to change the entity structure during the exchange. Consult an attorney on the "same taxpayer" rule before moving forward.
• The holding period is less than 2 years. Consult a CPA on the risk of dealer-status challenge.
• The closing is 15 days away and no QI is engaged. Call a QI immediately and confirm availability.

Action: Do not commit to a full 1031 until the specialist review is complete.

RED LIGHT: STOP; GET A FORMAL OPINION

The client has one or more disqualifying facts. Do not engage a QI or run detailed planning. Instead, obtain a formal opinion from the client's CPA or tax attorney before proceeding.

Examples:

• The property is non-real property (personal property, equipment, securities). A 1031 exchange does not apply. Period.
• The property is a primary residence. Even if rented out in the past, it is not investment property now.
• The sale and purchase are in different entities (individual to LLC). The "same taxpayer" rule fails.
• Both the sale and purchase involve related parties, and the client has not consulted an attorney on the 2-year cliff rule.
• The client's status is that of a dealer (frequent buying and selling). A 1031 may not apply.

Action: Obtain a formal written opinion from a CPA or tax attorney. Do not engage a QI or commit to a 1031 strategy until that opinion is in hand.

When to Refer to Specialists

Refer to a CPA or Tax Attorney:

• Any dealer-status question.
• A holding period of less than 2 years.
• Related-party transactions (especially both sides related).
• Recent conversion of personal property to rental use.
• Uncertainty about the property's "productive use" status.
• Multi-state or international property.

Refer to an Attorney:

• Entity restructuring before or during the exchange.
• Title issues or liens on the relinquished property.
• Divorce or estate settlement implications.
• Partnership or LLC operating agreement restrictions.

Refer to the CPA (Before and After Closing):

• Basis calculations and depreciation schedules.
• Boot and gain calculations.
• Deferred gain tracking for future exchanges or death.
• Form 8824 preparation and tax return integration.

The Conversation with the Client

Once you have completed the quick screen, communicate your findings:

If Green Light: "Based on our conversation, your property qualifies for a 1031 exchange. This is a tax-deferred strategy, and I recommend we move forward with engaging a qualified intermediary and developing a replacement property strategy. Let me set up a meeting with your CPA and attorney to coordinate."

If Yellow Light: "Your property likely qualifies for a 1031 exchange, but we need to get clarity on a few details before we proceed. I am going to have a conversation with your CPA [or attorney] about [specific issue]. Once we have their input, we can move forward with confidence."

If Red Light: "Based on what you've shared, I have some concerns about whether a 1031 exchange will work for this property. Before we engage a qualified intermediary, I want to get a formal opinion from your tax advisor. This is not a dealbreaker, but we need to understand the tax implications before we commit. Can you send me your CPA's contact information?"