Normally when appreciated business assets are sold such as real estate, tax is owed on the appreciation. A Section 1031 “like kind” exchange is a way to defer this tax. However, the Tax Cuts and Jobs Act (TCJA) reduces the types of property eligible for this favorable tax treatment.
Section 1031 of the Internal Revenue Code allows you to defer gains on real or personal property used in a business or held for investment if, instead of selling it, you exchange it solely for property of a “like kind.” The tax benefit of an exchange is that you defer tax and, thereby, have use of the tax savings until you sell the replacement property. This technique is especially flexible for real estate, because virtually any type of real estate will be considered to be of a like kind, as long as it’s business or investment property. For example, you can exchange a warehouse for an office building, or an apartment complex for a strip mall.
An alternate approach is a “reverse” exchange. Here, an exchange accommodation titleholder (EAT) acquires title to the replacement property before you sell the relinquished property. You can defer capital gains by identifying one or more properties to exchange within 45 days after the EAT receives the replacement property and, typically, completing the transaction within 180 days.
There had been some concern that tax reform would include the elimination of like-kind exchanges. The good news is that the TCJA still generally allows tax-deferred like-kind exchanges of business and investment real estate. But there’s also some bad news: for 2018 and beyond, the TCJA eliminates tax-deferred like-kind exchange treatment for exchanges of personal property. However, prior-law rules that allow like-kind exchanges of personal property still apply if one leg of an exchange was completed by December 31, 2017, but one leg remained open on that date. Keep in mind that exchanged personal property must be of the same asset or product class.
The rules for like-kind exchanges are complex, so these arrangements present some risks. If, say, you exchange the wrong kind of property or acquire cash or other non-like-kind property in a deal, you may still end up incurring a sizable tax hit. If you’re exploring a like-kind exchange, contact us at 508-888-2000 or firstname.lastname@example.org. We can help you ensure you’re in compliance with the rules.