Editorial · April 21, 2019
Like-kind exchange: what business owners can still defer
A like-kind exchange lets a business owner swap one piece of business or investment real estate for another and put off the tax on the gain. The rule is section 1031 of the Internal Revenue Code. Since 2018 it covers real property only. Machinery, vehicles and other equipment no longer qualify.
What changed in 2018
Before 2018, section 1031 also applied to some swaps of personal property. A delivery van for a newer van was a common example. Equipment, vehicles, artwork, collectibles and patents all had a chance at deferral.
The Tax Cuts and Jobs Act, passed in December 2017, changed that. The IRS says the change took effect on January 1, 2018. Now the rule applies only to real property held for use in a trade or business or held for investment.
There is a transition rule. An exchange of personal or intangible property can still qualify if the owner gave up the old property, or received the new property, on or before December 31, 2017. Any swap that began and ended after that date is out.
One small carve-out remains. The IRS notes that certain exchanges of mutual ditch, reservoir or irrigation company stock are still eligible.
What counts as real property
The IRS describes real property, also called real estate, as land and generally anything built on or attached to it. The two properties must be of "like kind." That means the same nature or character. They may differ in grade or quality.
This is a wide test. Improved property is generally like-kind to unimproved property. The IRS gives the example of an apartment building and a parcel of raw land. A warehouse for a rental building can also fit, as long as both are held for business or investment.
There are limits. Real property in the United States is not like-kind to real property outside the country. Real property held primarily for sale, such as lots a developer builds on and sells, does not qualify. The 2018 instructions for Form 8824 also say that section 1031 does not apply to some exchanges involving tax-exempt use property under a lease.
The 45 day and 180 day clocks
Most owners do not swap two properties on the same day. They sell first and buy later. This is called a deferred exchange, and the statute sets two deadlines.
First, you must identify the replacement property within 45 days after you transfer the property you are giving up. Second, you must receive the replacement property by the earlier of two dates. One is 180 days after the transfer. The other is the due date of your tax return for that year, including extensions.
That second date matters late in the year. A sale in November or December can leave you less than 180 days before your return is due. Filing an extension can give you more time, but plan for the shorter window.
The deadlines do not bend. If you miss either one, the new property is treated as not like-kind. The gain may then be taxable in the year of the sale.
Using a qualified intermediary
In a deferred exchange, owners often hire a qualified intermediary, or QI. The QI holds the sale money so you never take it yourself, then uses it to buy the replacement property. The IRS treats the transfer and the receipt as a like-kind exchange when this is done correctly.
A QI does not give you extra time. The Form 8824 instructions say that if you miss the deadlines because of the QI, the deal will not count as a deferred exchange. The gain may be taxable in the year you transferred the property. Pick a QI with care and ask how it protects client funds.
Reporting the exchange on Form 8824
You report a like-kind exchange on Form 8824, which is filed with your tax return for the year you transfer the property. The IRS says the form helps you figure the gain you defer. It also helps you figure the basis of the property you receive.
The form matters most when cash or other property that is not like-kind changes hands. Extra cash or other property, often called boot, can make part of your gain taxable now. Form 8824 is where that portion is worked out.
Deferral is not the same as forgiveness. Your gain is pushed into the basis of the new property. You may owe the tax later, when you sell without another exchange.
A short checklist for owners
- Confirm both properties are real property held for business or investment.
- Write down the transfer date and count 45 and 180 days from it.
- Check your return due date, with extensions, against the 180 day mark.
- Plan for Form 8824 when you file.
- Talk to a tax professional before you sign a sale contract, not after.
This article is general information for business owners, not tax advice. Rules differ by situation.