Can I buy the building I currently rent for my business as my replacement property?

Using the building in your own business is a qualifying use, not a personal one

The statute asks how you hold the replacement, not who the tenant is. Reg. section 1.1031(a)-1(a)(1) says property held for investment 'may be exchanged for property held for productive use in a trade or business', so trading a rental house for the warehouse your company works out of is an ordinary like-kind exchange.

Like kind is broad for real estate. The same regulation says the words refer 'to the nature or character of the property and not to its grade or quality', and a building with land under it is real property under Reg. section 1.1031(a)-3(a)(1) whatever its use.

What the rule excludes is personal use and dealer property. An office suite is neither, and a 1031 does not require the replacement to produce rent from a stranger. For the wider list of what passes and what fails, see what qualifies for a 1031 exchange.

The person who sold must be the person who buys, and that is where most owner-user deals go wrong

Owner-users often sell a rental held in their own name while the business that pays rent is an S corporation or a multi-member LLC. If the operating company takes title to the new building, a different taxpayer has acquired the replacement and the exchange fails, however natural it feels to put the building inside the business.

The clean structure is to take title in your own name or a single-member LLC you own, then sign a lease to the operating company at market rent. The building is then held for rental use by the same taxpayer that sold, which is the point of the same-taxpayer rule.

That lease has a tax effect of its own. Under Reg. section 1.469-2(f)(6), net rent from property rented for use in a business in which you materially participate is treated as not from a passive activity, so it cannot soak up passive losses from your other rentals. Plan the rent with that in mind.

Who your landlord is, and what you already own in the space, decide the price you can pay with exchange money

If the landlord is a parent, a sibling or an entity you control, the purchase is from a related person under section 1031(f)(3). Rev. Rul. 2002-83 holds that a taxpayer who acquires replacement property 'formerly owned by a related party is not entitled to nonrecognition' if the related party receives cash for it. The detail is in buying replacement property from a relative.

Check the lease before you price the deal. If the lease leaves the tenant improvements you paid for in your ownership, you already own them and exchange funds can only buy the landlord's interest. The agreed price should describe what is actually transferring, and any built-out space you paid for is not new replacement value.

An unrelated landlord is the simple case, and the purchase can be negotiated like any other. If the landlord wants to sell before your own property closes, the order can be reversed with an accommodation titleholder; see the reverse exchange guide.

Worked example: a $1,000,000 rental sale buys an $800,000 building and leaves a gap

Hypothetical, round numbers; run your own numbers with your CPA. You sell a rental for $1,000,000 with a $400,000 adjusted basis and no mortgage, so the realized gain is $600,000. Your company's landlord, an unrelated investor, agrees to sell you the building at $800,000, and you take title in your single-member LLC.

If nothing else is bought, $200,000 stays with the intermediary and comes back as cash boot. Under section 1031(b) that $200,000 is taxable, and to the extent it comes from depreciation it is unrecaptured section 1250 gain taxed at up to 25% under IRS Topic 409.

Two ways to close the gap: buy a second identified property for at least $200,000, or pay more for the building only if extra value actually transfers. Spending the money on fit-out after you take title does not count, as explained in using exchange funds for repairs after closing.

• Building purchase: $800,000 of real property, deferred.
• Remaining $200,000: boot unless a second identified property absorbs it.
• New building basis: carried over from the rental, adjusted for any boot and added cash.

A trust interest is the usual way to absorb what the building price leaves over

Owner-occupied buildings rarely price to the exact dollar of your proceeds. A Delaware Statutory Trust interest can be sized to the remainder, which is why owner-users often name one as a second or third property on the identification notice before day 45. How a split works is in splitting an exchange between a DST and direct property.

The trust interest is a passive holding with its own risks: no control over the property, limited liquidity and a sponsor's fees. It does not change the rules for the building itself, which you still identify, title and lease the same way. See traditional DST exchanges for how the interest is structured.