Like-Kind Exchange

How Is a Kind Exchange?

A like-kind exchange is a tax-deferred transaction that considers the disposal of an asset and the acquisition of another comparable asset without generating a capital gains tax liability from the sale of the first asset.

Until the section of tax legislation in December 2017, that might have incorporated the exchange of one business for another — or one piece of substantial property, like work of art or heavy equipment, for another. After 2017, a like-kind exchange applies just to the exchange of a business or real estate investment property for another property.

How a Like-Kind Exchange Works

At the point when a commercial property or investment property is sold for a gain, the investor is required to pay a capital gains tax on the profit earned. All capital gains are taxed at either the short-term capital gains rate between 10% to 37% for profits made on a sale in the span of one year or the long-term rate, which falls between 10% to 20% for profits made on a sale following one year of the initial purchase date.

A like-kind exchange is otherwise called a 1031 exchange or a Starker exchange.

Notwithstanding, Section 1031 of the Internal Revenue Code (IRC) excludes an investor from making a tax payment on a gain on the off chance that the proceeds from the sale or disposal of the property are reinvested in a comparative property of equivalent or greater value as part of a qualifying like-kind exchange. Any real estate, with the exception of one's very own residence, is viewed as like-kind to some other real estate. Generally, any real estate property held for useful use in the trade or business or for investment meets all requirements for a like-kind exchange.

A taxpayer that sells a piece of investment property and buys one more inside a stipulated time limit won't need to pay tax on the first disposal. They should pay tax upon sale or disposal of the second property except if another like-kind exchange is finished, in which case the tax payment will be deferred again.

There are several important contemplations to keep as a top priority with a like-kind exchange to guarantee that a tax liability isn't made upon the sale of the first asset:

1. The asset being sold must be an investment property and can't be a personal residence.
2. The asset being purchased with the proceeds must be like the asset being sold.
3. The proceeds from the sale must be utilized to purchase the other asset in somewhere around 180 days of the sale of the first asset, in spite of the fact that you must distinguish the property or asset that you are purchasing in the like-kind exchange in no less than 45 days of the sale.

There are a few limitations on the amount of capital gain that is tax-deferred, so guarantee that you check the most recent tax rules before continuing with a like-kind exchange.

Special Considerations

Notwithstanding the tax deferral benefits, a like-kind exchange permits the seller to concede their depreciation recapture-the gain received from the sale of depreciable capital property that must be reported as income for income tax purposes. A taxpayer can likewise stay away from state taxes on like-kind exchanges.

For instance, a few states expect that either a buyer or seller pay state income taxes when a property is sold, known as state mandatory withholding. Property moved in a like-kind exchange, be that as it may, can receive an exemption. To claim the exemption, the taxpayer should sign an exemption form or certificate given by the state. A few states require the seller to present the exemption 20 days before closing, while different states might permit the exemption form to submitted at close.

Benefits and Disadvantages of a Like-Kind Exchange

The most over the top glaring benefit of a like-kind exchange is the favorable tax treatment. Under this exchange, an asset can be replaced with a like-kind asset without triggering a taxable event. The exchange need not be with an asset indistinguishable from the one being replaced; it must be in a similar asset class.

The IRS draws no line on how frequently somebody can do a 1031 exchange. In this way, investors can constantly search for additional lucrative opportunities. Likewise, money that would have been utilized to pay capital gains taxes is available for reinvestment.

Albeit a like-kind exchange offers tax benefits, they are transitory. Taxes are deferred, not dispensed with. Eventually, capital gains taxes will be due. Likewise, on the off chance that the exchange doesn't occur inside the recommended period or as per IRS rules, the transaction will become taxable.

Just as capital gains taxes are deferred, losses are as well. A like-kind exchange that incorporates losses must be carried forward.

A like-kind exchange is ideal for a business owner hoping to sell their business and invest in another or a real estate investor hoping to sell a rental property and buy a comparative one. A 8824 Form must be recorded with the Internal Revenue Service (IRS) enumerating the terms of the deal. Gain recognized in light of the fact that boot — money, liabilities, or other property that isn't like-kind and that is given or received in a like-kind exchange — was received is reported on Form 8949, Schedule D (Form 1040), or Form 4797, as applicable. On the off chance that depreciation must be recaptured, this recognized gain might need to be reported as ordinary income.

Like-Kind Exchange FAQs

What Is the Purpose of a Third-Party Intermediary in a Deferred Like-Kind Exchange?

The third-party intermediary, or qualified intermediary, satisfies documentation requirements and guarantees that sales proceeds are held until the exchange is complete and that the exchange complies with IRS rules. Given the complexity of these transactions, there are benefits to working with a full-service 1031 exchange company with a laid out history.

How Do You Report a Like-Kind Exchange That Falls in Two Tax Years?

For a fruitful like-kind exchange that rides two years, the taxpayer will report the transaction on IRS Form 8824. The exchange will be reported for the year where the exchange started. For exchange funds received in the next tax year, the taxpayer will report those proceeds on IRS Form 6252.

For a failed like-kind exchange that rides two tax years, the taxpayer might be required to report any gains under the installment method. Even however they don't fit the bill for the like-kind exchange, they actually might have the option to concede gains for one year.

When Is a Realized Loss Recognized in a Like-Kind Exchange?

A loss isn't realized until the transaction becomes taxable. Under a like-kind exchange, capital losses are tax-deferred just like capital gains are.

The Bottom Line

A like-kind exchange offers favorable tax benefits to the people who qualify. Taxpayers can keep on conceding capital gains tax endlessly and have no restrictions on how frequently they can perform like-kind exchanges. The IRS sets severe rules on what can be exchanged and when. Regardless of its benefits, taxpayers must know that losses under a like-kind exchange are deferred and taxes are not avoidable.

Features

• A like-kind exchange is utilized when somebody needs to sell an asset and secure a comparative one while keeping away from the capital gains tax.
• Like-kind exchanges are intensely checked by the IRS and require accurate bookkeeping to guarantee that no tax penalty is incurred.
• Adroit sellers can utilize the like-kind exchange to concede other specific types of gains, like depreciation.
• Taxes under a like-kind exchange are deferred, not dispensed with.
• A like-kind exchange permits the seller to concede their depreciation recapture.