WHAT IS A LIKE-KIND-EXCHANGE?
The sale of business or investment assets that result in a gain is generally a taxable event. Section 1031 of the Internal Revenue Code provides an exception to this rule by allowing postponement of the payment of tax on the sale of property if you reinvest the proceeds in a property that is similar to the one sold.
This is known as an IRC section 1031 like-kind exchange. This qualifying exchange allows the business owner or the investor to defer the payment of tax, but the transaction is not permanently tax-free. There are qualification requirement before a person can take advantage of section 1031.
QUALIFICATIONS TO ENGAGE IN A 1031 LIKE-KIND EXCHANGE
As attractive as a like-kind exchange is to a person looking to sell property and avoid paying tax on the gain, there are some stipulations and requirements before the transaction can qualify as a tax-free exchange.
- The number one stipulation is that the property must be used in a business or for investment purposes. In other words, the property must be an income-producing asset; for example, rental property or equipment used in a business. Another requirement is that the property must reside in the United States.
- To qualify as a like-kind exchange, the transaction must be different from simply selling a property and using the proceeds to purchase another property; Such a transaction is considered two separate transactions and therefore, A like-kind exchange must be structured as a single transaction and facilitated by an intermediary.
- Property used as a primary residence or for vacation purposes do not qualify for like-kind-exchange.
- Both real property (Land and anything attached to it) and personal property (all other business assets that can be moved and that is not permanently attached to anything) qualify for like-kind exchange treatment. However, real property can only be exchanged for other real property, and personal property can only be exchanged for other personal
PROPERTY EXCLUDED FROM LIKE-KIND-EXCHANGE TREATMENT
There are certain types of property that are not eligible for like-kind-exchange treatment. For Example:
- Certificates of trust
- Partnership interests
REQUIRED TIME LIMIT TO COMPLETE A LIKE-KIND EXCHANGE
Although a like-kind exchange is not required to be a simultaneous swap, there are time imposed limits in which the entire transaction must occur. These limits can only be extended in the event of a presidentially declared disaster.
Under the first required limit, you have 45 days from the day you sell your property to identify a replacement property. After the identification of a property, you must sign an acknowledgement stating that you have found a replacement property and the signed statement must be delivered to the seller or the seller’s intermediary. Notifying your attorney, your accountant, or your real estate agent is not sufficient. The signed statement must include a very clear and explicit description of the identified property.
The second time limit is the time in which the entire transaction must be completed. The replacement property must be received, and the exchange completed no later than 180 days from the day you sold the property you are exchanging or the due date (including extension) of the return you file that corresponds to the year in which the exchange took place, whichever is earlier.
Finally, If you sell the property you are exchanging before you identify replacement property, make sure only your chosen facilitator holds the proceeds until the transaction is complete. If you handle the proceeds yourself, you are opening yourself up to paying tax on the profits. You cannot act as your own facilitator.
Section 1031 like-kind exchanges are reported on IRS form 8824.
Have a great week!!!
Desarie Anderson, CPA, EA
Anderson Accounting, LLC