Tax Reform for Real Estate Owners: Like-Kind Exchanges
Real estate owners seeking to realize their gains and not recognize them for tax purposes are in luck as a key section of the U.S. tax code remains in place following the latest tax reform. Lawmakers debated significant changes to like-kind exchanges under IRC §1031, but the House and Senate agreed to keep this means for tax deferral intact, with some minor changes to removing like-kind exchanges for personal property.
What is an IRC §1031 Like-Kind Exchange?
An exchange of property, like a sale, generally is a taxable event. However, under IRC §1031 no gain or loss is recognized if property held for productive use in a trade or business or for investment was exchanged for property of a “like-kind”, which is to be held for productive use in a trade or business or for investment. The IRC §1031 like-kind exchange method has been advantageous for real estate investors looking to maximize their investments by deferring taxes derived from the gains on sale. To do so, the proceeds from the sale must be rolled into the purchase of another like-kind property. Investors utilizing the IRC §1031 structure have only 45 days to identify potential replacement properties and must close within 180 days — tight deadlines in a hot market like this. The transaction must also go through an independent, qualified intermediary who handles funds from sale through exchange.
For exchanges completed prior to December 31, 2017, real property and personal property both qualify as exchange properties under IRC §1031. In personal property exchanges, the rules pertaining to what qualifies as like-kind are more restrictive than the rules pertaining to real property.
For exchanges completed after December 31, 2017, the benefits of the IRC §1031 like-kind exchange non-recognition of gain provisions are limited to real property, provided the real property is not held primarily for sale. Thus, exchanges of tangible and intangible personal property will no longer qualify for non-recognition treatment. Despite the change in rules, an exception is provided for any exchange if the property disposed of by the taxpayer in the exchange is disposed of on or before December 31, 2017 or, in the case of a reverse exchange, the replacement property is acquired by the taxpayer on or before December 31, 2017.
Impact on Individuals and Businesses
Investors in real estate are still able to defer the tax gains from the sale of real estate used in a business or held for investment and reinvest the proceeds into another property through an IRC §1031 like-kind exchange. However, personal property, such as equipment, airplanes, art, collectibles and intangibles, no longer qualify under the new tax law.
If an investor cannot find a suitable replacement property, there are other options. Investors can buy into a Delaware Statutory Trust (DST), securing a pro rata beneficial interest in the trust. Similar to real estate investment trusts, DSTs own a portfolio of investment properties that produce a steady stream of income and still qualifies as a mechanism to defer capital gains tax through the IRC §1031 like-kind exchange structure.