Exchanging
Property to Avoid Tax on the Gain
What is Like-Kind Property?
Section 1031 of the Internal Revenue Code contains a
very popular rule allowing you to exchange your business property for
like-kind property instead of selling it and paying tax on the gain.
Qualifying property must be property used in your trade or business,
rental property, or property held for investment.
There are a few strict rules that you must follow in order for an exchange
to escape tax under Section 1031.
First, you must use a qualified intermediary to
facilitate the exchange. If you have any constructive use of the sales
proceeds at any time during the exchange period, you just made a taxable
sale.
Second, timing is everything. Once you transfer the
property to the qualified intermediary, you have 45 days to identify the
replacement property and 180 days to acquire it.
Third, the property must be like-kind property. In
other words, you cannot exchange business equipment for a rental property.
The property, both given up and received, must be in the same asset class.
The rules for real property are a bit more relaxed. When it comes to real
estate, the quality or grade doesn't matter. You can exchange unimproved
land for land with buildings on it, or vice versa.
A Section 1031 exchange CAN be partly taxable, to the
extent that one participant in the exchange receives extra cash (called
boot), or has excess debt assumed by the other participant.
Section 1031 exchanges of like-kind property can be
very complicated and it is strongly recommended that any taxpayer
considering one consult both a tax professional and an expert in 1031
exchanges.
