Postpone Immediate Tax Payments through a Like-Kind Exchange

Despite recent challenges in certain real estate markets, profitable opportunities with potentially high tax implications still arise, making the like-kind exchange strategy an appealing option. In essence, a like-kind exchange involves swapping real property held for investment or business use (relinquished property) for similar investment, trade, or business real property (replacement property). While the definition of "like-kind" is broad, it excludes real property held primarily for sale. Rudler, PSC delves into the intricacies of like-kind exchanges, covering the eligibility criteria, potential tax implications, and the impact of the Tax Cuts and Jobs Act on such transactions.

Asset-for-asset or boot
Under the Tax Cuts and Jobs Act, tax-deferred Section 1031 treatment is no longer allowed for exchanges of personal property — such as equipment and certain personal property building components — that are completed after December 31, 2017.

If you are unsure if the property involved in your exchange is eligible for like-kind treatment, please contact your Rudler, PSC advisor to discuss the matter.

Assuming the exchange qualifies, here’s how the tax rules work. If it’s a straight asset-for-asset exchange, you won’t have to recognize any gain from the exchange. You will take the same “basis” (your cost for tax purposes) in the replacement property that you had in the relinquished property. Even if you do not have to recognize any gain on the exchange, you still must report it on Form 8824, “Like-Kind Exchanges.”

However, in many cases, the properties are not equal in value, so some cash or other property is added to the deal. This cash or other property is known as “boot.” If boot is involved, you will have to recognize your gain, but only up to the amount of boot you receive in the exchange. In these situations, the basis you get in the like-kind replacement property you receive is equal to the basis you had in the relinquished property reduced by the amount of boot you received but increased by the amount of any gain recognized.

How it works
For example, let’s say you exchange business property with a basis of $100,000 for a building 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. That’s the amount of cash (boot) you received. Your basis in the new building (the replacement property) will be $100,000: your original basis in the relinquished property ($100,000) plus the $15,000 gain recognized, minus the $15,000 boot received.

Note that no matter how much boot is received, you’ll never recognize more than your actual (“realized”) gain on the exchange.

If the property you are exchanging is subject to debt from which you are being relieved, the amount of the debt is treated as boot. The reason is that if someone takes over your debt, it is equivalent to the person giving you cash. Of course, if the replacement property is also subject to debt, then you’re only treated as receiving 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).

Unload one property and replace it with another
Like-kind exchanges can be a great way to dispose of investment, trade, or business real property tax deferred. But you have to make sure to meet all the requirements. If you are considering doing a like kind exchange contact your Rudler, PSC advisor at 859-331-1717 as there are many rules and specific steps that need to happen in order to qualify.