Like-Kind Exchanges in Real Estate

Wilmington, NC is a top tourist destination and we see a lot of clients with rental properties and a general desire to get involved in the real estate market. Buying and selling real estate may not have seemed like such a great idea a few years ago, but Business Insider magazine ranked Wilmington 13th in best housing markets for the next five years. There are many tax planning strategies available that business owners can use to help defer some of the taxable gain on properties that they buy and sell. One of these is a Section 1031 Deferred Like-Kind Exchange.

Section 1031 Deferred Like-Kind Exchange

Under Code Section 1031, gains on investments and business properties can be deferred in a like-kind exchange. This is set up as a tax deferral rather than a tax avoidance. One of the benefits of the 1031 exchange is to defer gains to future tax years when taxable income is lower. By deferring tax on gains clients have more money in their pockets now to invest. Section 1031 exchanges can be used by individuals, C Corporations, S Corporations, partnerships, LLCs and trusts.

What is like-kind property?

Both properties must be held for use in a trade or business or for investment. Quality or grade does not usually matter. Most real estate will be like-kind to other real estate.

If you receive cash, relief from debt, or property that is not like-kind you may trigger some taxable gain in the year of the exchange. It is recommended to use exchange facilitators to ensure all appropriate documents are drawn up.

Time Limits to Complete Section 1031 Deferred Like-Kind Exchange

–          You have 45 days from the date you sell the relinquished property to identify potential replacement properties. Identification must be in writing, signed by purchaser and delivered to someone involved in the exchange. This is usually the seller or qualified intermediary. Real estate agents, attorneys, and accountants are not sufficient.

–          Replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date with extensions of the income tax return for the tax year in which the relinquished property was sold. Whichever date is earlier applies.

Things to Remember

Using a qualified intermediary is the key to a successful like-kind exchange. Note that taxpayers cannot act as their own intermediary. Taking control of cash or other proceeds before the exchange is complete could result in all of the gain immediately taxable. If cash or other proceeds are received in an exchange they may be taxable but only to the extent that they are not like-kind property.