Can I make a gift with a 1031 exchange?

By G. Scott Haislet, CPA, Esq.

Q: Can you gift an interest in a property resulting from a 1031 exchange into a 529 plan for grandchildren?

Federal tax code section 529 provides for qualified tuition programs, commonly called 529 plans.

Federal tax code section 529(b)(2) states, "A program shall not be treated as a qualified tuition program unless it provides that purchases or contributions may only be made in cash."

On the other hand, property from a 1031 exchange is likely a rental property. A 1031 exchange is found in tax code section 1031. That law provides that gain or loss from sale of a business or investment property will be avoided (deferred) upon acquisition of a like kind replacement property. Absent the acquisition of the replacement property, the taxpayer would recognize gain or loss upon sale of the business or investment property.

Thus, the short answer is that you can't contribute previously received 1031 replacement property to a 529 plan. The contribution must be cash. If a taxpayer wishes to contribute previously received 1031 replacement property to a 529 plan, he must sell the property, which triggers the taxable gain avoided earlier in the 1031 exchange. Then he can give the cash proceeds.

Make sure you understand the sum of the federal and state tax liability upon selling a property obtained in a prior 1031 exchange. The results can be surprising.

Example: Bill obtained property called "Blackacre" in a 1031 exchange. He paid $300,000 for Blackacre, but his cost for determining gain or loss was $100k (because he deferred gain of $200,000 in the earlier 1031 exchange). Now, Bill wants to sell Blackacre because its value fell to $250,000. If he sells Blackacre, he will have a taxable gain of $150,000 ($250,000 sale price minus tax cost or "basis" of $100,000), even though he lost $50,000 economically on Blackacre.

Note that 1031 exchanges are quite involved, raise many questions, and require professional assistance. Even experienced real estate brokers and investors often misconstrue a variety of the 1031 rules and nuances to their later chagrin. It's OK to initiate 1031 "education" with Internet sources, but smart taxpayers will review their situation with a CPA experienced with 1031 exchanges before taking action.

G. Scott Haislet, CPA, Esq. is a tax adviser, estate planner and real estate attorney.

Have a question for a CPA? here.

In accordance with IRS Circular 230, the information on this website is not intended or written to be used, and cannot be used as or considered a "covered opinion" or other written tax advice and should not be relied upon for the purpose of avoiding tax-related penalties under the Internal Revenue Code; promoting, marketing, or recommending to another party any transaction or tax-related matter(s) addressed herein; for IRS audit, tax dispute or other purposes.