The idea behind this section of the tax code is that when an individual or a business sells a property to buy another, no economic gain has been achieved. For example, if a real estate investor sells an apartment building to buy another one, he or she will not be charged tax on any gains he or she made on the original apartment building. When the investor sells the original apartment building and purchases a new one, the value used from the original to buy the new one has not changed – the only thing that has changed is where the value resides.

Luckily this list is much shorter than the list of properties that do qualify. The list of “like-kind” property is constantly being reevaluated by law makers. Exchangers should always engage with a licensed CPA and Qualified Intermediary for the latest “like-kind” qualifications.

The second deadline is the 180-Day Exchange Period, during which the taxpayer must receive the replacement property. This period can be cut short if the taxpayer’s tax return for the year of the sale is due before the 180 days have passed. For exchanges late in the tax year, a filing extension is often needed to use the full 180-day window. These two time periods like-kind exchange run concurrently, and there are no extensions, making careful planning a necessity.

In other words, the taxpayer is not divesting, but rather continuing an ongoing investment. Only real property held for business or investment purposes and not held primarily for sale (e.g., inventory) qualifies for a like-kind exchange. Both the relinquished property and the property received must be held for qualifying investment purposes, but the properties do not need to be held for the same purpose.

According to the National Association of Realtors, median home prices in September 2021 were up 13.3% compared with the same time a year earlier (NAR, Summary of September 2021 Existing Home Sales Statistics). Meanwhile, interest rates on 30-year fixed-rate mortgages have remained flat at an attractive rate of just above 3% on average. Investors who have experienced appreciation in the current strong real estate market might consider selling their property while housing prices are at market highs, which for many would mean recognizing capital gains.

Navigating Like-Kind Exchange Rules Under Section 1031

Section 1031 of the IRS Code exempts the seller of the property from paying capital gains as long as the property is for business and investment purposes. The seller must purchase like-kind property every time they sell property in order to defer taxes for the longest time period possible. Usually, when a property is bought or sold, the gain realized in the process is chargeable to capital gains tax. Depending on the period of holding, they are charged with a long-term or short-term capital gain tax.

Like-Kind Exchange

• The timeline begins the moment the original property is sold and its ownership is transferred.
• Through this process, you sell your relinquished property and identify a replacement property within 45 days of that sale.
• In a deferred or delayed exchange, the time between the sale of your current property and the purchase of a new property are separate from one another.
• Securities, stocks, bonds, partnership interests, and other financial assets are not considered like-kind properties and are exempt from tax deferrals.

Investing in real estate may offer steady passive income, as well as unique tax advantages. But strong real estate appreciation means that the sale of an investment property can come at a big tax cost. Depending on the holding period of the property and whether depreciation deductions have been taken, gains can be taxed at ordinary income rates.

Like-kind exchange

• Similarly, property held “primarily for sale,” such as a house flipped by a real estate developer or lots held by a builder, is also disqualified.
• The most difficult issue may be the relatively short time frames to complete the acquisition and closing the deal.
• The unrecognized gain or unrecognized loss from a like-kind exchange is preserved in the new property received in the exchange.
• However, the cost tends to be higher, and it may require more available liquidity to handle potential repairs and maintenance.
• The Internal Revenue Code defines a like-kind property as any held for investment, trade, or business purposes under Section 1031.

The complexities of like-kind exchange rules require careful planning and legal guidance. Our Arkansas real estate attorneys specialize in Section 1031 transactions and can help structure your exchange to maximize tax advantages while ensuring compliance with IRC 1031 regulations. Contact us today to discuss how a 1031 like-kind exchange can fit within your business or investment strategies and benefit you. In addition to what is considered a traditional forward 1031 like-kind exchange, taxpayers can also complete a “reverse” 1031 like-kind exchange. In a “reverse” exchange, the replacement  or new investment property is purchased before the investment property currently held by the taxpayer is sold. Reverse exchanges are much more complex than a traditional forward exchange and require several additional steps to complete.

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This involves taking on an equal or greater amount of debt and reinvesting all cash proceeds. Using a qualified intermediary is standard practice to prevent the taxpayer from having constructive receipt of sale proceeds, which would be treated as taxable boot. Also, if the exchange does not take place within the prescribed period or according to IRS rules, the transaction will become taxable. What makes 1031 exchanges potentially useful is that they may allow you to defer the payment of any capital gains tax normally due from a sale.

Key Exchange Rules and Timelines

For instance, if the mortgage on the new property is $50,000 less than the old one, that $50,000 is taxable boot. Cash boot occurs when the taxpayer receives cash from the sale proceeds instead of having the full amount reinvested. Any cash taken from the exchange, either for personal use or to pay for non-qualified closing expenses, is taxable up to the amount of the gain. Under a like-kind exchange, capital losses are tax-deferred just like capital gains are. For example, some states require that either a buyer or seller pay state income taxes when a property is sold, known as state mandatory withholding. Property transferred in a like-kind exchange, however, can receive an exemption.

Potential recapture pitfall for profits-interest partners

Sec. 1031 is a decades-old tax provision that has incentivized growth in the real estate industry for many years. However, Sec. 1031 may not be a viable option for high-income taxpayers in the future, given the current political climate. Successful completion of a like-kind exchange is an extremely rules-based endeavor, which, in most cases, will require the assistance of both a CPA and an independent intermediary to achieve the desired outcome. Planning, preparation, and execution of a like-kind exchange is a very rules-based endeavor.

Do I need to notify USCIS of a change in sponsor’s financial status after filing I-485?

You receive the property from your EAT when renovations have been completed. Also known as a “forward” exchange, the delayed 1031 exchange is widely regarded as the most common. Through this process, you sell your relinquished property and identify a replacement property within 45 days of that sale. You then close on the replacement property within 180 days of the sale of your relinquished property. In a tax-deferred exchange, the tax basis of the relinquished property is carried over to the replacement property.