Important Considerations When Engaging in a Like-Kind Exchange

• What is a like-kind exchange?
• Learn about tax rules for like-kind exchanges.
• Find out how “boot” applies in a like-kind exchange.
• Discover a real-world example of a like-kind exchange.

How might a business or individual dispose of appreciated real property without taxation on the gain? By exchanging it rather than selling it. You can defer tax on your gain through a “like-kind” or Section 1031 exchange.

We call the swap of real property held for investment or for productive use in your trade or business for like-kind investment real property or business real property a like-kind exchange. For these purposes, “like-kind” has a very broad definition. We consider most real property to be like-kind to other real property. However, neither the relinquished property nor the replacement property can be real property held primarily for sale or used for personal purposes. Unsure of the eligibility of the property involved in your like-kind exchange? Your Fiducial representative can help!

Here’s how the tax rules work for a like-kind exchange

If it’s a straight asset-for-asset exchange, you won’t have to recognize any gain from the like-kind exchange. You’ll take the same “basis” (your cost for tax purposes) in the replacement property that you had in the relinquished property. But what if you don’t have to recognize any gain on the exchange? Then you still have to report the exchange on a form attached to your tax return.

However, the properties often aren’t equal in value. So, some cash or other (non-like-kind) property can enter into the deal. We call this cash or other property “boot.” If your like-kind exchange involves boot, you’ll have to recognize your gain, but only up to the amount of boot you receive in the exchange. In these situations, the basis you obtain in the like-kind replacement property you receive equals the basis you had in the relinquished property you gave up reduced by the amount of boot you received but increased by the amount of any gain recognized.

Here’s an example

Let’s say you exchange land (investment property) with a basis of $100,000 for a building (investment property) valued at $120,000 plus $15,000 in cash. Your realized gain on the exchange is $35,000. You received $135,000 in value for an asset with a basis of $100,000. However, since it’s a like-kind exchange, you only have to recognize $15,000 of your gain: the amount of cash (boot) you received. Your basis in the new building (the replacement property) will equal $100,000, your original basis in the relinquished property you gave up ($100,000) plus the $15,000 gain recognized, minus the $15,000 boot received.

Note:

No matter how much boot you receive, you’ll never recognize more than your actual (“realized”) gain on the exchange.

What if the property you’re exchanging is subject to debt from which you’re being relieved? Then we treat the amount of the debt as boot. The theory is that if someone takes over your debt, it’s equivalent to him or her giving you cash. But what if the replacement property is also subject to debt? Then you’re only treated as receiving a boot to the extent of your “net debt relief” (the amount by which the debt you become free of exceeds the debt you pick up).

A like-kind exchange has its complexities. However, they’re a good tax-deferred way to dispose of investment or trade, or business assets. Have additional questions or need assistance with a transaction? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.

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