Short answer
Raw land 1031 exchanges involve the exchange of undeveloped or vacant land for another like-kind property that is held for investment or business purposes. Land can be exchanged for a building and a building for land, because all U.S. real estate held for investment is like-kind. Most raw land exchanges that fail do so for one of a few reasons: the owner was really a developer or dealer holding lots for sale, they tried to build on land they already owned with exchange money, or they swapped a leveraged rental for land and didn't replace the debt. The nine pitfalls below cover those and the less obvious ones.
| # | Pitfall | Fix |
|---|---|---|
| 1 | Land held for sale, not investment (dealer status) | Hold as an investor; develop in a separate entity |
| 2 | Building on land you already own with exchange money | Buy new land through an improvement exchange |
| 3 | Not replacing debt when going into land | Add cash or finance the land |
| 4 | Losing depreciation and cash flow | Run the numbers before trading a building for land |
| 5 | Recapture surprises on buildings exchanged for land | Have your CPA check cost-segregated components |
| 6 | Paying carrying costs with exchange funds | Pay taxes and holding costs with your own money |
| 7 | Weak identification of parcels | Use legal descriptions or parcel numbers |
| 8 | Zoning, access or entitlement problems found too late | Do due diligence before day 45 |
| 9 | Seller financing on the land you sell | Plan the note before closing |
On this page
- 011. Dealer status: land held for sale
- 022. Building on land you already own
- 033. Not replacing the debt
- 044. Losing depreciation and cash flow
- 055. Recapture on buildings exchanged for land
- 066. Paying carrying costs with exchange funds
- 077. Weak identification
- 088. Zoning, access and entitlement problems
- 099. Seller financing on the land you sell
- 10If you plan to develop land
- 11Frequently asked questions
- 12Sources
1. Dealer status: land held for sale
Section 1031 doesn't cover property held primarily for sale. If you subdivide, put in roads and utilities, and sell lots to builders, the IRS can treat the land as dealer inventory, which can't be exchanged. Investors who hold land for appreciation, or rent it for farming or grazing, are on firmer ground.
Fix: if you plan to develop, many advisors suggest selling the raw land at its investment value to a separate development company you own, then developing there. The investment gain can be handled separately from the development profit. See 1031 exchanges from a developer's perspective, and get tax advice before you subdivide.
2. Building on land you already own
A common plan is to sell a rental and use the money to build on a lot you already own. That doesn't work: improvements on land you already hold aren't like-kind property you receive, and Rev. Proc. 2004-51 keeps that structure outside the reverse-exchange safe harbor.
Fix: buy new land through an exchange accommodation titleholder and build on it before day 180. See 1031 into property you already own and build-to-suit exchanges.
3. Not replacing the debt
Example: you sell a $1,200,000 fourplex with a $500,000 mortgage and use the $700,000 of net proceeds to buy $700,000 of land for cash. You reinvested all the cash, but you bought $500,000 less than you sold and took on no new debt, so the $500,000 of debt relief is boot. Land loans are harder to get, and many land buyers pay cash.
Fix: add your own cash for the gap, get a land loan or seller financing on the purchase, or split the proceeds between land and a financed property. See debt replacement.
4. Losing depreciation and cash flow
Land isn't depreciated, so trading a rental building for land ends your depreciation deductions. Raw land also usually produces little or no income while you pay property taxes. The exchange is still valid; the pitfall is economic.
Fix: compare after-tax cash flow for both properties. Going the other way, from land into a building, starts depreciation on the building portion. See depreciation in a 1031 exchange.
5. Recapture on buildings exchanged for land
If the building you sell had a cost segregation study, some of it was depreciated as shorter-lived property. When the replacement is only land, some of that depreciation can be taxed now as recapture even though the exchange is otherwise valid. Fix: ask your CPA to check before you identify land-only replacements. See depreciation recapture rules.
6. Paying carrying costs with exchange funds
Property tax prorations, HOA dues, insurance and maintenance on the new land aren't acquisition costs. If the QI pays them from exchange funds, they can be treated as cash you received. Fix: pay them yourself at or after closing.
7. Weak identification
Land often has no street address. An identification that says "10 acres off County Road 12" can be challenged. Under Treas. Reg. §1.1031(k)-1(c), the property must be unambiguously described. Fix: use the legal description or assessor's parcel number. If you are buying part of a larger tract, attach a survey or map. See the 45-day rule.
8. Zoning, access and entitlement problems
Land deals fall apart over things buildings rarely have: no legal access, wetlands, flood zones, unbuildable soils, or zoning that won't allow your plan. If a deal dies after day 45 and it was your only identified property, the exchange fails. Fix: do the major checks before you identify, and identify backup parcels. See due diligence for replacement property.
9. Seller financing on the land you sell
Land buyers often ask the seller to carry a note. A note isn't cash that the QI can reinvest, so the note amount is taxed unless it is handled within the exchange. Fix: plan the note structure before closing. See how to carry the paper.
If you plan to develop land
| Plan | Exchange approach |
|---|---|
| Hold land for long-term appreciation | Standard exchange in or out |
| Build a rental on new land | Improvement exchange, or buy the land in the exchange and build later with other money |
| Subdivide and sell lots | Lot sales are likely dealer sales and taxed; plan the land's investment gain separately |
| Ground-lease the land to a developer | A long ground lease keeps you an investor; leases of 30+ years can also be exchanged |
Entitlement can take years, so it rarely fits inside 180 days. Many developers do entitlement work before selling or after buying, not during the exchange. For the short answer on vacant land, see our FAQ can you 1031 exchange vacant land?, and for farmland see the ranch and farm guide. Ready to sell land? Check whether your property qualifies.
Frequently asked questions
Can you do a 1031 exchange with raw land?
Yes. Raw land held for investment is like-kind to any other U.S. real estate held for investment or business, including buildings.
Can I exchange a rental property for land?
Yes. The main things to watch are replacing the debt and losing depreciation, because land isn't depreciated.
Can I use 1031 money to build on land I already own?
No. Improvements on land you already own don't count as property received. You need to buy new land through an improvement exchange.
Can a land developer do a 1031 exchange?
Not on land held primarily for sale, such as subdivided lots. Land held for investment can be exchanged.
How do I identify land without a street address?
Use the legal description or assessor's parcel number, and attach a survey or map if it is part of a larger tract.
Sources
- 26 U.S.C. §1031 (property held primarily for sale excluded)
- Treas. Reg. §1.1031(k)-1 (identification must be unambiguous, §1.1031(k)-1(c))
- Rev. Proc. 2004-51 (limit on improving property you already own)
- Treas. Reg. §1.1031(a)-1 (like-kind refers to nature or character)
This article is general information, not tax or legal advice. Talk to your CPA or tax attorney about your situation.
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