1031's under TCJA

Typically when property is sold any gain must be reported as taxable income. IRS Code Section 1031 allows for the deferral of tax of gain on sale of property by so-called like-kind exchanges, also known as 1031 exchanges. They work under the simple premise implied by the name: property is exchanged for like-kind property, and when all the rules are followed any gain that would have been taxable is deferred.

The deferral is allowed because the basis in the newly acquired property is reduced by the amount of gain recognized. Thus, the gain is eventually recognized when the new property is sold, because the decreased basis increases the amount of gain on sale (unless, somehow, the gain is deferred again by another like-kind exchange).

Like-kind exchanges do not require the literal trading of property between two parties. Instead, one taxpayer typically takes the proceeds of a sold property, and uses those proceeds to acquire another, like-kind property, usually from a third party.

The exchange can include like-kind property exclusively or it can include like-kind property along with cash, liabilities and property that are not like-kind. If you receive cash, relief from debt, or property that is not like-kind, however, you may trigger some taxable gain in the year of the exchange. There can be both deferred and recognized gain in the same transaction when a taxpayer exchanges for like-kind property of lesser value. To avoid all gain on a sale, generally you must reinvest all proceeds and pay more, whether by cash or debt.

In a 1031 exchange both the relinquished property you sell and the replacement property you buy must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment. (Because of the generous rules under Code Section 121, though, most people don’t need to worry about this anyway.)

Former law stated that real property and personal property could both qualify as exchange properties under Section 1031. This meant business equipment could be exchanged for business equipment, with any gain deferred accordingly. For example, a trucking company could trade one tractor trailer for another, and any gain on disposition would not be taxed. Under President Trump’s new Tax Cut and Jobs Act, however, like-kind exchanges are now allowed only for real property.

Fortunately, most real estate will be like-kind to other real estate. For example, real property that is improved with a residential rental house is like-kind to vacant land. One exception for real estate is that property within the United States is not like-kind to property outside of the United States. Also, improvements that are conveyed without land are not of like-kind to land.

It is important to understand that while a like-kind exchange does not have to be a simultaneous swap of properties, you must meet two time limits or the entire gain will be taxable. These limits cannot be extended for any circumstance or hardship except in the case of presidentially declared disasters. 

The first limit is that you have 45 days from the date you sell the relinquished property to identify potential replacement properties. The identification must be in writing, signed by you and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary. Notice to your attorney, real estate agent, accountant or similar persons acting as your agent is not sufficient. Replacement properties must be clearly described in the written identification. This means a legal description, street address or distinguishable name.

The second limit is that the 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 is earlier. The replacement property received must be substantially the same as the property identified within the 45-day limit described above.

Section 1031 like-kind exchanges are not complicated, but there are strict rules. To make sure you are able to defer the tax on your sale of property call us or speak to a qualified intermediary before you sell your property. If you don’t, it will be too late, and your gain will be taxable.

Credit to irs.gov for assistance with content and wording.
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