Selling a Business Asset? Here’s How to Make the Gain Tax Free

The sale of a business asset can create a large tax liability. However, if structured properly, performing a 1031 “like-kind” exchange for business property allows taxpayers to defer the recognition of gain, and save money. But you need to be quick!

A 1031 exchange occurs when you sell an asset, such as a building, for an asset of similar kind. Of course, the key here is that by deferring gain, taxpayers avoid a large tax bill. Proceeds from the sale of the original property are reinvested in the new property.

In order for the sale to qualify for non-recognition of gain, the assets being exchanged must be of “like-kind” (of the same type, like two pieces of residential real estate), but do not have to be of the same quality. The property cannot be “investments”, such as stocks and bonds. And, the property cannot be for personal use, partnership interests, or inventory.

In addition, the taxpayer must identify replacement property. The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day.

After the taxpayer has properly identified replacement property, the transaction must be completed relatively quickly.

The timing begins:

  • On the date the taxpayer transfers the relinquished property

And ends:

  • At midnight on the earlier of the 180th day or the due date (including extensions) for the taxpayer’s tax return for the tax year in which the transfer of the relinquished property occurs.

One additional item the IRS requires for deferral of gain under like-kind exchange is the use of a Qualified Intermediary (QI), as a facilitator or exchange accommodator. Choosing a QI to facilitate the 1031 exchange is usually the first and one of the most important steps. The QI should be a company/individual that works on a full-time business of facilitating 1031 exchanges. IRS regulations require that the person or entity serving as QI cannot be someone with whom the exchanger has had a former business or family relationship prior to the transaction. A QI has to be an independent organization whose only contact with the exchanger is to serve as a QI.

When performed properly, like-kind exchanges can save a substantial amount of money. Be sure to contact a tax professional if you are considering a like-kind exchange to make sure you have met all of the rules and regulations.