A Like-Kind Exchange (also known as a 1031 Exchange), is a method to temporarily bypass capital gains taxes by investing proceeds from the sale of a property into a similar property.
About the Topic
To be a like kind exchange all six of the following must be met:
- Property traded (not sold) and property received must be held by the taxpayer for business or investment purposes.
- Property must not be inventory.
- There must be an exchange of property.
- Exchanges of intangible property cause problems...more homework is required.
- Property to be received must be identified within 45 days.
- Property must be received within 180 days or the due date (including extensions) of the tax returns.
The exchange of property for the same kind of property is the most common type of nontaxable exchange. To be a like-kind exchange, the property traded and the property received must be both of the following.
- Qualifying property.
- Like-kind property.
Additional requirements apply to exchanges in which the property received is not received immediately upon the transfer of the property given up. If the like-kind exchange involves the receipt of money or unlike property or the assumption of your liabilities, you may have to recognize gain.
Multiple-party transactions. The like-kind exchange rules also apply to property exchanges that involve three- and four-party transactions. Any part of these multiple-party transactions can qualify as a like-kind exchange if it meets all the requirements described in this section.
Receipt of title from third party. If you receive property in a like-kind exchange and the other party who transfers the property to you does not give you the title, but a third party does, you still can treat this transaction as a like-kind exchange if it meets all the requirements.
Basis of property received. If you acquire property in a like-kind exchange, the basis of that property is the same as the basis of the property you transferred.
Example. You exchanged real estate held for investment with an adjusted basis of $25,000 for other real estate held for investment. The fair market value of both properties is $50,000. The basis of your new property is the same as the basis of the old ($25,000).
Money paid. If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized gain or loss. The basis of the property received is the basis of the property given up, increased by the money paid.
Example. Bill Smith trades an old cab for a new one. The new cab costs $30,000. He is allowed $8,000 for the old cab and pays $22,000 cash. He has no recognized gain or loss on the transaction regardless of the adjusted basis of his old cab. If Bill sold the old cab to a third party for $8,000 and bought a new one, he would have a recognized gain or loss on the sale of his old cab equal to the difference between the amount realized and the adjusted basis of the old cab.
Sale and purchase. If you sell property and buy similar property in two mutually dependent transactions, you may have to treat the sale and purchase as a single nontaxable exchange.
Example. You used your car in your business for 2 years. Its adjusted basis is $3,500 and its trade-in value is $4,500. You are interested in a new car that costs $20,000. Ordinarily, you would trade your old car for the new one and pay the dealer $15,500. Your basis for depreciation of the new car would then be $19,000 ($15,500 plus $3,500 adjusted basis of the old car).
You want your new car to have a larger basis for depreciation, so you arrange to sell your old car to the dealer for $4,500. You then buy the new one for $20,000 from the same dealer. However, you are treated as having exchanged your old car for the new one because the sale and purchase are reciprocal and mutually dependent. Your basis for depreciation for the new car is $19,000, the same as if you traded the old car.
Reporting the exchange. Report the exchange of like-kind property, even though no gain or loss is recognized, on Form 8824. The instructions for the form explain how to report the details of the exchange.
If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040) or Form 4797, whichever applies. You may have to report the recognized gain as ordinary income from depreciation recapture.
Exchange expenses. Exchange expenses are generally the closing costs you pay. They include such items as brokerage commissions, attorney fees, and deed preparation fees. Subtract these expenses from the consideration received to figure the amount realized on the exchange. Also, add them to the basis of the like-kind property received. If you receive cash or unlike property in addition to the like-kind property and realize a gain on the exchange, subtract the expenses from the cash or fair market value of the unlike property. Then, use the net amount to figure the recognized gain.
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Related Code Sections
Related Treasury Regulations
- Sec. 1.1031(a)-1 Property held for productive use in trade or business or for investment
- Sec. 1.1031(a)-2 Additional rules for exchanges of personal property
- Sec. 1.1031(a)-2T Additional rules for exchanges of personal property (temporary)
- Sec. 1.1031(b)-1 Receipt of other property or money in tax-free exchange
- Sec. 1.1031(b)-2 Safe harbor for qualified intermediaries
- Sec. 1.1031(c)-1 Nonrecognition of loss
- Sec. 1.1031(d)-1 Property acquired upon a tax-free exchange
- Sec. 1.1031(d)-1T Coordination of section 1060 with section 1031 (temporary)
- Sec. 1.1031(d)-2 Treatment of assumption of liabilities
- Sec. 1.1031(e)-1 Exchange of livestock of different sexes
- Sec. 1.1031(j)-1 Exchanges of multiple properties
- Sec. 1.1031(k)-1 Treatment of deferred exchanges