19 Jun Like-Kind Exchanges
Ordinarily, a gain on the sale of business or investment property is subject to tax. However, a special provision of the Internal Revenue Code (IRC) allows for sellers in these types of transactions to postpone recognition of the gain if certain conditions are met.
IRC §1031 defers the recognition of gain (and therefore the tax on the gain) on the sale of business or investment property if that transaction is part of a “like-kind exchange.” A like-kind exchange occurs when the relinquished property (the property being sold) and the replacement property (the property being acquired) meet certain requirements. The first requirement is that each property must be held for use in a trade or business or for investment purposes. Therefore, property held for personal use does not qualify for a like-kind exchange. The second requirement is that the relinquished property and the replacement property must be considered like-kind. This means they must have the same nature, character, or class. Generally, real estate is like-kind to other real estate. However, property held within the U.S. is not like-kind to property outside of the U.S. Furthermore, while both real and personal property can qualify as like-kind, they are not like-kind with each other. Additionally, personal property has more strict rules than real property. For example, cars are not like-kind to trucks.
The following property is excluded from the provisions of §1031:
- Inventory or stock in trade
- Stocks, bonds, or notes
- Other securities or debt
- Partnership interests
- Certificates of trust
Section 1031 postpones recognition of the gain if all the proceeds are reinvested in similar property as part of a qualifying like-kind exchange. Therefore, the gain on the sale of the property is tax-deferred and not tax-free. The exchange can include like-kind property exclusively or like-kind property along with cash, liabilities, and property that is not like-kind. However, if the seller receives cash, debt relief, or property that is not like-kind, it may cause a tax event on the gain in the year of the exchange. Similarly, if not all the proceeds are reinvested in replacement property then some of the gain may be recognized.
Individuals, C-corporations, S-corporations, partnerships, limited liability companies, trusts, and any other tax-paying entity may take advantage of the §1031 exchange provision so long as there is an exchange of property. The simplest form of exchange is a swap of property for another which occurs at the same time. Alternatively, a deferred exchange can occur. This type of exchange provides for greater flexibility, but is more complex. Under this form of exchange, the disposition of sold property and the acquisition of the replacement property must be mutually dependent parts of a single, integrated transaction that makes up an exchange of property.
Tax law is often complex and obtaining quality legal representation is critical. If you have questions related to potential tax implications of your business,speak with the experienced tax law attorneys at the Royse Law Firm. We have offices in Palo Alto and San Francisco.Disclaimer: This blog and website are public sources of general information concerning our firm and its lawyers, as well as the information presented. They are intended, but not promised or guaranteed, to be correct, complete, and up-to-date as of the date posted. This blog and website are not intended to be, and are not, sources of legal opinion or advice. The materials, information, and communications on this blog and website do not apply to any particular person, entity, or situation, and do not apply to you or to your specific situation. You will need to consult with an attorney and/or other appropriate professional about your specific situation. Thank you.