Tax Free Exchanges Rising in Popularity

Let’s make a deal….Tax-Free! Now that I have your attention, let’s talk about Code Sec. 1031, a “like-kind” exchange of business property. A “like-kind” exchange allows taxpayers to dispose of an asset and acquire another similar asset without generating a tax liability from the sale of the first asset.

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 term “like-kind” is broad, and the rules are surprisingly liberal. 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.

This is not a new concept by any stretch of the imagination. In fact, “like-kind” exchanges have remained in the tax code since 1921. Recently, “like-kind” exchanges have risen in popularity for many reasons. The market is definitely on an uprising and deals are being made left and right. Additionally, with the rising market come big gains upon sale. Since the capital gain rates were recently raised, people are looking closer deferring their gain.

Upon recent years, proposals have been made to repeal Code Sec. 1031. With that said, if you have property that meets the specifications of a “like-kind”, don’t procrastinate or you may lose out on this tax saving opportunity in the future. As usual, there are other items to consider in a “like-kind” transaction that involve receiving cash, property with outstanding mortgages, or other debt. As always, I recommend consulting with your CPA before implementing “like-kind” exchanges or any other tax strategy on your own to make sure your situation meets the proper rules and regulations.