1031 Like-Kind Exchanges: Qualifications and Deferred Exchange Mechanics
“Like-Kind Exchanges,” or a 1031, is an issue that our tax team frequently handles. So here’s the 411 on what you need to know about a 1031. Like-Kind Exchanges occur when investment or business properties are exchanged solely for similar property that will be held for similar use. No gain or loss is recognized when this exchange transpires, so long as the properties exchanged are properties of a similar nature and when the property given up and the property received are to be held for productive use in a trade, business or investment. However, gain or loss may be recognized on an exchange when money or other property that is not of a “like-kind” is received in the exchange or liabilities are assumed.
The term “like-kind” is an obscure phrase that has a wide range of what qualifies under the 1031 exchanges. For both properties to qualify for a 1031 exchange, they must be of a similar nature, or of a like-kind, hence the inspiration behind the name of this type of exchange. The nature or character of the property involved in the exchange is what defines it is a Like-Kind Exchange, not its grade or quality. These exchanges can encompass business, real estate, personal property, even automobiles and the list goes on.
The simplest exchange under this tax provision is the immediate swap of one property for another. A next level of the 1031 exchange is a deferred exchange which is a bit more complex but allows for more flexibility. In a deferred exchange, the relinquished property and gaining of replacement property must be equally dependent parts of an integrated transaction, constituting an exchange of property.
The next level of complexity in a 1031 exchange is referred to as a reverse exchange. This involves the obtainment of replacement property through an exchange accommodation titleholder, whoever holds it for no more than 180 days. During this time period the taxpayer disposes of the resigned property to close said exchange.
Now there are time limits to complete a deferred like-kind exchange, or the entire gain will be taxable. The first limit is 45 days from the date you sell the relinquished property to when you identify potential replacement properties. The identification process for this is a bit more complex and involved than, for example, calling “shotgun” in a car. Identification must be in writing, signed by you and delivered to a seller or qualified intermediary.
The second time frame is no later than 180 days after the sale of the exchanged property that the replacement property must be received and the exchange completed, OR the due date (with extensions) of the income tax return for the tax year when the relinquished property was sold.
For further information regarding Like-Kind Exchanges or qualifications, please contact our office to speak with one of our tax professionals.