If you are thinking as a Realtor, Broker or Real Estate Professional of selling real property that you use in your trade or business or that you are holding for investment, you should consider the benefits of a Like-Kind Exchange (Code Section 1031).
In a Like-Kind Exchange (Code Section 1031), the Realtor, Broker or Real Estate Professional does not recognize any gain or loss on the disposition of real property held for the productive use in a trade or business or for investment if you dispose of the property by exchanging it solely for property of like kind that is to be held either for productive use in a trade or business or for investment. If, in addition to receiving like-kind property, you receive cash or other property that does not qualify as like-kind property (so-called “boot”), you must recognize gain to the extent of the boot received.
Example:
Residential rental property exchanged for another residential rental property.
In a Like-Kind Exchange (Code Section 1031), the gain realized on the exchange of real property for replacement property does not escape tax – the tax on the gain is merely deferred until you sell the replacement property. However, by deferring the tax, you’ll have more money available to invest in another property. In effect, you receive an interest-free loan from the federal government, in the amount you would have paid in taxes. Also, any gain from depreciation recapture is postponed except to the extent you receive boot as part of the exchange and recognize gain. Further, because of the way the term “like kind” is defined, you may use the acquisition and disposition of properties to reallocate your investment portfolio (e.g., moving from commercial rental property to residential rental property) without paying tax on any gain.
To qualify as a Like-Kind Exchange (Code Section 1031), both the property you give up (the relinquished property) and the property you receive (the replacement property) must be held for investment or for productive use in your trade or business. While taxpayers were able to use the like-kind exchange rules for exchanges of personal property in years beginning before 2018, such exchanges are no longer available. Only real property is eligible for the like-kind exchanges rules. Examples of property that may qualify include land and rental houses. The like-kind exchange rules do not apply to real property held primarily for sale. Unproductive real estate held by someone other than a dealer for future use or future realization of the increment in value is considered held for investment and not primarily for sale.
Also, to qualify as a Like-Kind Exchange (Code Section 1031), the replacement property must be of a “like kind” to the relinquished property. “Like kind” refers to the nature and character of the property and not to its grade or quality. An exchange of one kind or class of property for a different kind or class is not a like-kind exchange. All qualifying real property located in the United States, improved or unimproved, is considered to be of like kind.
Additional requirements apply to deferred Like-Kind Exchange (Code Section 1031) in which you do not receive the replacement property immediately upon your transfer of the relinquished property.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
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Palm Desert, CA 92260
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(Updated 03/09/2021 07:20)