Are you planning to sell any business or investment property that you anticipate will generate a large gain? If so, it is essential to consider the tax consequences that may come as a result of that sale. Generally, you are required to pay tax on that gain. However, an exception under Internal Revenue Code (IRC) Section 1031, described as a like-kind exchange, allows you to defer this tax in certain situations. This article will provide you with the basic requirements for executing a like-kind exchange successfully.
If you are considering selling business or investment property that will result in a large gain and you do not currently need the cash resulting from the transaction, this may be an opportunity to participate in a section 1031 exchange in order to defer any tax owed. When completing a like-kind exchange, the tax on the gain resulting from the sale may be deferred as long as a new property of equal or greater value is acquired. However, there are certain requirements that must apply in order to qualify for a successful like-kind exchange. These include the following:
- Both the property being sold and the property being purchased must be real property, which includes land or a building, that is not held primarily for sale. This requirement was introduced with the new tax legislation put into effect for the 2018 tax year. Previously all business and investment assets were eligible to be used in a 1031 exchange, however, this has been changed effective January 1st, 2018.
- Both properties must be “Like-kind”, however, this has a broad definition, so property involved in an exchange does not have to be an exact match. For example, a house may be exchanged for an apartment building.
- Any deferred exchange, defined as a disposition of relinquished property and acquisition of replacement property in separate transactions which must be mutually dependent parts of an integrated transaction constituting an exchange of property, must use a qualified exchange intermediary (QEI) to facilitate the transaction. If the cash from the sale is distributed to the owner at any time you have created a taxable sale.
- Your replacement property must be identified within 45 days of the closing date of the relinquished property. However, you may identify up to 3 properties within this time frame. Once property is identified you must notify the qualified intermediary in writing of your intent to acquire the property.
- You must close on the replacement property within 180 days from the date on which you close the sale of the relinquished property.
- You will be taxed on any cash that you receive from the transaction (which is referred to as “boot” in an exchange).
- Even if you do not receive any cash from the transaction, boot may still exist. Boot could be in the form of cash, debt relief/reduction or any additional property that is received (i.e. security deposits).
These requirements are simply a guideline and do not include all of the rules that exist regarding a 1031 exchange. If you are contemplating a like-kind exchange of property, it is imperative that you have the proper guidance when structuring the transaction in order to comply with the rules. Please feel free to contact your L&B professional at 858-558-9200 to further discuss these details.