Like-kind swaps in 1031 Exchanges are frequently misunderstood. What are like-kind exchanges? As the market continues to improve, it appears that many investors are looking to switch to a different type of real estate investment. This is for those who want to know about What Is a Like-Kind Exchange?

A Like-Kind Exchange: What Is It?

For example, a like-kind exchange allows the sale of one item and purchase of another item without incurring a capital gains tax burden from the first item's sale. This might have included the transfer of a business or a tangible asset like artwork or even heavy equipment prior to the enactment of tax regulations in December 2017. When a company or investment property is traded for another property, a like-kind exchange can only be used for this purpose.

How Like-Kind Exchange Works?

Exchange of like-kind is free from federal income tax under Section 1031. Only commercial or investment real estate can now be sold under this rule, which went into effect in 2017. Because of this law, holders of these assets can trade or sell the asset and obtain a similar property without paying capital gains taxes. In addition, it permits the delay of recognition until the gain has been reclaimed. In order to be eligible for this tax break, transactions must match the following criteria:

• The property being sold must be used for business or be an investment (i.e., it cannot be a personal residence).
• The money must be put to good use by purchasing a company or an asset for investment.
• The seller has a total of 45 days after the sale to locate another property that is comparable to the one being sold, and they have up to 180 days after the sale to actually complete the purchase.
• An IRS Form 8824 must be completed by the seller in order to describe the terms of the transaction.
• Depending on that and how the property is held, the seller must declare any boot gain on Form 1040, Form 8949, or Form 4797.

Special Considerations

In addition to letting the seller put off paying taxes, a like-kind exchange lets the seller put off paying taxes on the gain from the sale of the accumulated depreciation capital property, which must be noted as income for tax purposes. Like-kind exchanges can also help a taxpayer avoid paying state taxes.

Mandatory state income tax withholding is an example of this practice in some jurisdictions, when either the buyer or seller of a property is required to pay state income taxes. However, the property exchanged in a like-kind trade may be excluded from taxation. To get the tax break, the taxpayer will have to sign a form or certificate that the state gives them. While other jurisdictions might permit the exemption from being presented at closing, some states demand that the seller submit it 20 days prior to closing.

A Like-Kind Exchange Example

Anyone wishing to sell their company and buy another one, or even a real estate investor selling a rental property in return for buying another one, would benefit greatly from doing so on the basis of like-kind exchanges. The IRS requires a completed Form 8824 outlining the conditions of the agreement. Tax forms 8949, Schedule D (Form 1040), and/or 4797 are used to report gains that are considered boot or property that is not transferred or received in a like-kind transaction. Depreciation recapture may necessitate reporting a realized gain as regular income.

A Like-Kind Alternative

Donating the property to a non-profit organization can be an alternative to a like-kind exchange. A deed or title transfer is an easy way for the property owner to make a gift. By doing this, the donor avoids paying capital gains tax and receives a tax deduction equivalent to the property's fair market value. The 1031 exchange is indeed a clever strategy for business owners to delay federal taxes as well as continue to grow the company's assets.

Conclusion

The tax advantages of a like-kind exchange are available to individuals who qualify for them. There are no limits on the number of like-kind exchanges that can be made by taxpayers, and they can defer capital gains tax forever. The IRS has very specific rules on what and when can be traded. The benefits of a like-kind exchange are overshadowed by the fact that tax consequences are unavoidable.