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<title>like-kind exchange – HARP – On This. . .</title>
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<title>SECTION 1031 EXCHANGE BASICS – Planning for 2021</title>
<link>http://harp-onthis.com/section-1031-exchange-basics-planning-for-2021/</link>
<comments>http://harp-onthis.com/section-1031-exchange-basics-planning-for-2021/#comments</comments>
<dc:creator><![CDATA[Kymn Harp]]></dc:creator>
<pubDate>Fri, 01 Jan 2021 09:12:00 +0000</pubDate>
<category><![CDATA[#CRE]]></category>
<category><![CDATA[#CREbasics]]></category>
<category><![CDATA[Commercial Real Estate]]></category>
<category><![CDATA[2021]]></category>
<category><![CDATA[attorney]]></category>
<category><![CDATA[buying real estate]]></category>
<category><![CDATA[Chicago]]></category>
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<category><![CDATA[commercial real estate]]></category>
<category><![CDATA[Illinois]]></category>
<category><![CDATA[industrial property]]></category>
<category><![CDATA[investing in real estate]]></category>
<category><![CDATA[investment property]]></category>
<category><![CDATA[like-kind exchange]]></category>
<category><![CDATA[NNN]]></category>
<category><![CDATA[planning for 2021]]></category>
<category><![CDATA[real estate]]></category>
<category><![CDATA[real estate lawyer]]></category>
<category><![CDATA[Section 1031 exchanges]]></category>
<category><![CDATA[selling real estate]]></category>
<category><![CDATA[tax deferred exchange]]></category>
<category><![CDATA[tax free exchange]]></category>
<category><![CDATA[tax planning]]></category>
<category><![CDATA[tax savings]]></category>
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<description><![CDATA[Prediction: Tax rates will rise, and property values will increase in 2021 and beyond. IRC Section 1031 allows real estate sellers to defer payment of taxes . . . possibly forever. ]]></description>
<content:encoded><![CDATA[
<p><strong><em><u>PREDICTION</u></em></strong><strong><em>: Tax rates will rise, and property values will increase.</em></strong></p>
<p><strong><em>IRC Section 1031 allows sellers of qualifying real estate to exchange it for like-kind real estate and defer payment of taxes. . . possibly forever.</em></strong></p>
<div class="wp-block-image is-style-rounded">
<figure class="aligncenter size-large is-resized"><img data-recalc-dims="1" decoding="async" data-attachment-id="1527" data-permalink="http://harp-onthis.com/harp-photo-sept-2019-less-than-2mb/" data-orig-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/09/Harp-Photo-Sept.-2019-less-than-2MB.png?fit=360%2C402" data-orig-size="360,402" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":"","orientation":"0"}" data-image-title="Harp Photo – Sept. 2019 less than 2MB" data-image-description="" data-image-caption="<p>R. Kymn Harp</p>
" data-medium-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/09/Harp-Photo-Sept.-2019-less-than-2MB.png?fit=269%2C300" data-large-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/09/Harp-Photo-Sept.-2019-less-than-2MB.png?fit=360%2C402" src="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/09/Harp-Photo-Sept.-2019-less-than-2MB.png?resize=180%2C201" alt="" class="wp-image-1527" width="180" height="201" srcset="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/09/Harp-Photo-Sept.-2019-less-than-2MB.png?w=360 360w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/09/Harp-Photo-Sept.-2019-less-than-2MB.png?resize=269%2C300 269w" sizes="(max-width: 180px) 100vw, 180px" /><figcaption class="wp-element-caption">R. Kymn Harp</figcaption></figure></div>
<h3 class="wp-block-heading"><strong>WHAT IS A TAX-DEFERRED EXCHANGE?</strong></h3>
<div class="wp-block-image">
<figure class="alignright size-full is-resized"><img data-recalc-dims="1" fetchpriority="high" decoding="async" data-attachment-id="1913" data-permalink="http://harp-onthis.com/section-1031-exchange-basics-planning-for-2021/section-1031/" data-orig-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/section-1031.jpg?fit=1024%2C671" data-orig-size="1024,671" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":"","orientation":"0"}" data-image-title="section-1031" data-image-description="" data-image-caption="" data-medium-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/section-1031.jpg?fit=300%2C197" data-large-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/section-1031.jpg?fit=1024%2C671" src="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/section-1031.jpg?resize=400%2C261" alt="section 1031" class="wp-image-1913" width="400" height="261" srcset="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/section-1031.jpg?w=1024 1024w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/section-1031.jpg?resize=300%2C197 300w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/section-1031.jpg?resize=768%2C503 768w" sizes="(max-width: 400px) 100vw, 400px" /></figure></div>
<p>Section 1031 of the Internal Revenue Code allows any real estate in the USA held for investment or for use in the taxpayer’s trade or business to be exchanged for other like-kind property without payment of federal income taxes. Most states tax codes provide likewise. There are technical rules for completing the exchange, but it is a straightforward process with clear-cut rules expressly authorized by law.</p>
<p>Taxes that can be deferred include all capital gains taxes, all depreciation recapture taxes, all passive-investment taxes (so called “Obamacare taxes”), and, in most cases, state income taxes. In many circumstances, these taxes can add up to in excess of 30%. Instead of paying taxes, why not reinvest those funds as equity in another like-kind property instead, and continue to receive an investment return on those funds?</p>
<h3 class="wp-block-heading"><strong>HOW IS <em>LIKE-KIND</em> PROPERTY DEFINED?</strong></h3>
<ul class="wp-block-list">
<li>A concept that is often misunderstood is “like-kind” property. The definition is much broader and simpler that some might expect. Basically, any real estate located in the USA and held for investment or for use in the taxpayer’s trade or business can be exchanged for any other USA real estate held for investment or for use in the taxpayer’s trade or business without paying taxes. That means, for example:</li>
</ul>
<div class="wp-block-group"><div class="wp-block-group__inner-container is-layout-constrained wp-block-group-is-layout-constrained">
<div class="wp-block-group"><div class="wp-block-group__inner-container is-layout-constrained wp-block-group-is-layout-constrained">
<ul class="wp-block-list">
<li>An apartment building could be exchanged for a warehouse, retail store, or farm, and <em>vice versa</em>. </li>
<li>Vacant land held for investment could be exchanged for a shopping center. </li>
<li>An apartment building could be exchanged for an office building. </li>
</ul>
</div></div>
</div></div>
<p>The physical use of the real estate is not what makes it like-kind; rather, all real estate located in the USA is like-kind to all other real estate located in the USA. Likewise, foreign real estate is like-kind to other foreign real estate, but it is not like-kind to USA real estate. The condition is that (i) the real estate being sold must have been held for investment or for use in the taxpayer’s trade or business, and not held primarily for resale, and (ii) the real estate being acquired must likewise be acquired for investment purposes or for use in the taxpayer’s trade or business and not primarily for resale.</p>
<h3 class="wp-block-heading"><strong>ARE THERE TIME CONSTRAINTS?</strong></h3>
<p>At the time of closing, the taxpayer does not need to know exactly what property will replace the property being sold. The taxpayer has 45 days to identify potential replacement property, and up to 180 days after closing to acquire the replacement property. A key, however, is that the selling taxpayer cannot come into physical or constructive possession of the sale proceeds during the exchange period. To satisfy this condition, the seller will designate a qualified intermediary to hold the funds under an exchange trust agreement. This can be done quickly, often within a day or two before closing if necessary. Although the seller/taxpayer does not have the right to access the funds during the exchange period, the seller/taxpayer does have the right to direct the qualified intermediary to apply the funds toward the taxpayer’s purchase of any replacement property which is identified by the taxpayer during the 45-day identification period.</p>
<p>For all taxes to be deferred, the entire sale proceeds of the real estate being sold must be used to acquire the replacement property. For this purpose, “sale proceeds” includes all cash received at closing and any mortgage indebtedness that was paid off.</p>
<h3 class="wp-block-heading"><strong>INCIDENTAL PERSONAL PROPERTY</strong></h3>
<p>Prior to January 1, 2018 tax-deferred exchanges of certain personal property were also permitted. The 2017 Tax Cuts and Jobs Act, effective January 1, 2018, ended this practice and limited tax-deferred like-kind exchanges to only real property. This raised concerns as to whether certain personal property commonly incidental to a sale of commercial property, such as appliances, carpeting, HVAC systems, security systems, Wi-Fi systems, trade fixtures, etc. would disqualify an exchange for tax deferral, or constitute taxable “boot”.</p>
<p>Under <a href="https://www.federalregister.gov/documents/2020/12/02/2020-26313/statutory-limitations-on-like-kind-exchanges" data-type="URL" data-id="https://www.federalregister.gov/documents/2020/12/02/2020-26313/statutory-limitations-on-like-kind-exchanges" target="_blank" rel="noreferrer noopener">Final Regulations</a> published by the Treasury Department effective December 2, 2020, personal property that is incidental to real property acquired in an exchange will be disregarded and may therefore be included as part of the tax-deferred exchange. Personal property is considered “incidental” in commercial transactions if (a) it is the type of personal property typically transferred together with real property, and (b) the aggregate fair market value of the personal property transferred with the real property does not exceed 15% of the aggregate fair market value of the replacement real property received in exchange. </p>
<h2 class="wp-block-heading"><strong>ADVANTAGES AND DISADVANTAGES</strong></h2>
<p>There are many advantages and not many disadvantages to structuring a sale as a tax-deferred exchange. The rules are technical but not very difficult to apply. It has virtually no impact on the buyer and provides extraordinary benefits to the seller.</p>
<p>For a real estate lawyer, besides providing a great service to your clients, an exchange provides a direct lead-in to the next transaction with an opportunity to handle the purchase of replacement property of equal or greater value that must close within 180 days.</p>
<p>Our tax code provides this benefit; it is up to real estate professionals to take advantage.</p>
<p><em>Thanks for listening . . .</em></p>
<p><em>Kymn</em></p>
<figure class="wp-block-image size-large"><img data-recalc-dims="1" decoding="async" width="578" height="339" data-attachment-id="1540" data-permalink="http://harp-onthis.com/rsp-50th-anniversary/" data-orig-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/12/RSP-50th-Anniversary.jpg?fit=578%2C339" data-orig-size="578,339" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":"","orientation":"0"}" data-image-title="RSP 50th Anniversary" data-image-description="" data-image-caption="<p>Celebrating 50 Years of Excellence!</p>
" data-medium-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/12/RSP-50th-Anniversary.jpg?fit=300%2C176" data-large-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/12/RSP-50th-Anniversary.jpg?fit=578%2C339" src="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/12/RSP-50th-Anniversary.jpg?resize=578%2C339" alt="" class="wp-image-1540" srcset="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/12/RSP-50th-Anniversary.jpg?w=578 578w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2019/12/RSP-50th-Anniversary.jpg?resize=300%2C176 300w" sizes="(max-width: 578px) 100vw, 578px" /><figcaption class="wp-element-caption">Celebrating 50 Years of Excellence!</figcaption></figure>
]]></content:encoded>
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<slash:comments>1</slash:comments>
<post-id xmlns="com-wordpress:feed-additions:1">1605</post-id> </item>
<item>
<title>Before Closing: Consider a Sec. 1031 Tax Deferred Exchange</title>
<link>http://harp-onthis.com/before-closing-consider-a-sec-1031-tax-deferred-exchange/</link>
<comments>http://harp-onthis.com/before-closing-consider-a-sec-1031-tax-deferred-exchange/#respond</comments>
<dc:creator><![CDATA[Kymn Harp]]></dc:creator>
<pubDate>Fri, 17 May 2019 19:23:40 +0000</pubDate>
<category><![CDATA[Commercial Real Estate]]></category>
<category><![CDATA[#CRE]]></category>
<category><![CDATA[commercial real estate]]></category>
<category><![CDATA[how to]]></category>
<category><![CDATA[investing]]></category>
<category><![CDATA[like-kind exchange]]></category>
<category><![CDATA[Section 1031]]></category>
<guid isPermaLink="false">http://harp-onthis.com/?p=1445</guid>
<description><![CDATA[If commercial real estate is being sold and the seller is planning to buy again, the seller should seriously consider a tax-deferred exchange. So long as the closing has not yet occurred, it is not too late. Why pay taxes […]]]></description>
<content:encoded><![CDATA[
<p>If
commercial real estate is being sold and the seller is planning to buy again,
the seller should seriously consider a tax-deferred exchange. So long as the
closing has not yet occurred, it is not too late. Why pay taxes on sale
proceeds when it’s not necessary? Invest those funds as equity instead.</p>
<figure class="wp-block-image"><img data-recalc-dims="1" loading="lazy" decoding="async" width="963" height="350" data-attachment-id="1041" data-permalink="http://harp-onthis.com/illinois-llcs-the-asset-protection-advantage/rsp_logohd-3/" data-orig-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2015/02/RSP_LogoHD-3.jpg?fit=963%2C350" data-orig-size="963,350" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":"","orientation":"1"}" data-image-title="RSP_LogoHD (3)" data-image-description="" data-image-caption="" data-medium-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2015/02/RSP_LogoHD-3.jpg?fit=300%2C109" data-large-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2015/02/RSP_LogoHD-3.jpg?fit=963%2C350" src="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2015/02/RSP_LogoHD-3.jpg?resize=963%2C350" alt="" class="wp-image-1041" srcset="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2015/02/RSP_LogoHD-3.jpg?w=963 963w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2015/02/RSP_LogoHD-3.jpg?resize=300%2C109 300w" sizes="auto, (max-width: 963px) 100vw, 963px" /></figure>
<h3 class="wp-block-heading"> <br /><strong>WHAT IS A TAX-DEFERRED EXCHANGE?</strong></h3>
<div class="wp-block-image">
<figure class="alignright size-full is-resized"><img data-recalc-dims="1" loading="lazy" decoding="async" data-attachment-id="1755" data-permalink="http://harp-onthis.com/before-closing-consider-a-sec-1031-tax-deferred-exchange/coinsmoneysettinggrowthupincreasetohousemodelfor/" data-orig-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/coins-money-setting-growth-up-increase-to-house.jpg?fit=1000%2C667" data-orig-size="1000,667" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"Shutterstock","camera":"","caption":"","created_timestamp":"0","copyright":"Copyright (c) 2019 Tinnakorn jorruang\/Shutterstock. No use without permission.","focal_length":"0","iso":"0","shutter_speed":"0","title":"Coins,Money,Setting,Growth,Up,Increase,To,House,Model,For","orientation":"1"}" data-image-title="Coins,Money,Setting,Growth,Up,Increase,To,House,Model,For" data-image-description="" data-image-caption="" data-medium-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/coins-money-setting-growth-up-increase-to-house.jpg?fit=300%2C200" data-large-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/coins-money-setting-growth-up-increase-to-house.jpg?fit=1000%2C667" src="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/coins-money-setting-growth-up-increase-to-house.jpg?resize=400%2C266" alt="coins money setting growth up increase to house" class="wp-image-1755" width="400" height="266" srcset="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/coins-money-setting-growth-up-increase-to-house.jpg?w=1000 1000w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/coins-money-setting-growth-up-increase-to-house.jpg?resize=300%2C200 300w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/coins-money-setting-growth-up-increase-to-house.jpg?resize=768%2C512 768w" sizes="auto, (max-width: 400px) 100vw, 400px" /></figure></div>
<p>Section
1031 of the Internal Revenue Code allows any real estate in the USA held for
investment or for use in the taxpayer’s trade or business to be exchanged for
other like-kind property without payment of federal income taxes. Most states
tax codes provide likewise. There are technical rules for completing the exchange,
but it is a straightforward process with clear-cut rules expressly authorized
by law. </p>
<p>Taxes that can be deferred include all capital gains taxes, all depreciation recapture taxes, all passive-investment taxes (so called “Obamacare taxes”), and, in most cases, state income taxes. In many circumstances, these taxes can add up to in excess of 30%. Why not reinvest those funds in another like-kind property instead, and continue to receive an investment return on those funds? <br /></p>
<h3 class="wp-block-heading"><br /><strong>HOW IS </strong><em><strong>LIKE-KIND</strong></em><strong> PROPERTY DEFINED?</strong> </h3>
<p>A
concept that is often misunderstood is “like-kind” property. The definition is
much broader and simpler that some might expect. Basically, any real estate
located in the USA and held for investment or for use in the taxpayer’s trade or
business can be exchanged for any other USA real estate held for investment or
for use in the taxpayer’s trade or business without paying taxes. That means,
for example, an apartment building could be exchanged for a warehouse, retail
store, or farm, and <em>vice versa</em>.
Vacant land held for investment could be exchanged for a shopping center. An
apartment building could be exchanged for an office building. The physical use of
the real estate is not what makes it like-kind; rather, all real estate located
in the USA is like-kind to all other real estate located in the USA. Likewise,
foreign real estate is like-kind to other foreign real estate, but it is not
like-kind to USA real estate. The condition is that the real estate being sold
must have been held for investment or for use in the taxpayer’s trade or
business, and the real estate being acquired must likewise be acquired for
investment purposes or for use in the taxpayer’s trade or business. </p>
<h3 class="wp-block-heading"> <br /><strong>ARE THERE TIME CONSTRAINTS? </strong> <strong><br /></strong></h3>
<p>At
the time of closing, the taxpayer does not need to know exactly what property
will replace the property being sold. The taxpayer has 45 days to identify
potential replacement property, and up to 180 days after closing to acquire the
replacement property. A key, however, is that the selling taxpayer cannot come
into physical or constructive possession of the sale proceeds during the
exchange period. To satisfy this condition, the seller will designate a
qualified intermediary to hold the funds under an exchange trust agreement. This
can be done quickly, often within a day or two before closing if necessary. Although
the seller/taxpayer does not have the right to access the funds during the
exchange period, the seller/taxpayer does have the right to direct the
qualified intermediary to apply the funds toward the taxpayer’s purchase of any
replacement property which is identified by the taxpayer during the 45-day
identification period. </p>
<p>For all taxes to be deferred, the entire sale proceeds of the real estate being sold must be used to acquire the replacement property. For this purpose, “sale proceeds” includes all cash received at closing and any mortgage indebtedness that was paid off.</p>
<h3 class="wp-block-heading"> <br /><strong>ADVANTAGES AND DISADVANTAGES</strong> </h3>
<p>There
are many advantages and not many disadvantages to structuring a sale as a
tax-deferred exchange. The rules are technical but not very difficult to apply.
It has virtually no impact on the buyer and provides extraordinary benefits to
the seller. </p>
<p>For
a broker, an exchange provides a direct lead-in to the next transaction, with
an opportunity to broker the purchase of replacement property of equal or
greater value that must close within 180 days. </p>
<p>Our
tax code provides this benefit; it is up to real estate professionals to take
advantage. </p>
]]></content:encoded>
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<slash:comments>0</slash:comments>
<post-id xmlns="com-wordpress:feed-additions:1">1445</post-id> </item>
<item>
<title>Keys Rules For Section 1031 Exchanges</title>
<link>http://harp-onthis.com/keys-rules-section-1031-exchanges/</link>
<comments>http://harp-onthis.com/keys-rules-section-1031-exchanges/#comments</comments>
<dc:creator><![CDATA[Kymn Harp]]></dc:creator>
<pubDate>Tue, 05 Aug 2014 11:10:02 +0000</pubDate>
<category><![CDATA[Business]]></category>
<category><![CDATA[Commercial Real Estate]]></category>
<category><![CDATA[White Papers]]></category>
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<category><![CDATA[capital gains]]></category>
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<category><![CDATA[Chicago]]></category>
<category><![CDATA[closing]]></category>
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<category><![CDATA[consequences]]></category>
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<guid isPermaLink="false">http://harp-onthis.com/?p=621</guid>
<description><![CDATA[This is the second installment of a three-part series on Section 1031 like-kind exchanges. Part 1 explained WHY you should consider use of a Section 1031 like-kind exchange when selling commercial or investment real property. Part 2 covers the key […]]]></description>
<content:encoded><![CDATA[
<p><i>This is the second installment of a three-part series on Section 1031 like-kind exchanges. <a title="Section 1031 Like-Kind Exchanges – Part 1 of 3" href="http://harp-onthis.com/business/section-1031-like-kind-exchanges-part-1-of-3/" target="_blank" rel="noopener"><span style="mso-bidi-font-weight: bold;">Part 1</span> explained WHY</a> you should consider use of a Section 1031 like-kind exchange when selling commercial or investment real property. <strong>Part 2</strong> covers the key rules for HOW to implement a Section 1031 like-kind exchange. Part 3 will cover special issues applicable to a Section 1031 like-kind exchange when a Tenant-In-Common [TIC] interest is being acquired.</i></p>
<h1 class="wp-block-heading">KEY RULES FOR SECTION 1031 EXCHANGES</h1>
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<figure class="alignleft"><a href="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2013/09/U.S.-Tax-image-iStock.jpg"><img data-recalc-dims="1" loading="lazy" decoding="async" width="153" height="300" data-attachment-id="615" data-permalink="http://harp-onthis.com/keys-rules-section-1031-exchanges/u-s-tax-image-istock/" data-orig-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2013/09/U.S.-Tax-image-iStock.jpg?fit=990%2C1939" data-orig-size="990,1939" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":""}" data-image-title="U.S. Tax image [iStock]" data-image-description="" data-image-caption="" data-medium-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2013/09/U.S.-Tax-image-iStock.jpg?fit=153%2C300" data-large-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2013/09/U.S.-Tax-image-iStock.jpg?fit=522%2C1024" src="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2013/09/U.S.-Tax-image-iStock.jpg?resize=153%2C300" alt="U.S. Tax image [iStock]" class="wp-image-615" srcset="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2013/09/U.S.-Tax-image-iStock.jpg?resize=153%2C300 153w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2013/09/U.S.-Tax-image-iStock.jpg?resize=522%2C1024 522w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2013/09/U.S.-Tax-image-iStock.jpg?w=990 990w" sizes="auto, (max-width: 153px) 100vw, 153px" /></a></figure></div>
<p><span style="font-size: 12.0pt;">The following is an outline of key rules applicable to Section 1031 exchanges. Become familiar with these rules. Unless you intend to completely cash out of real estate investing, a Section 1031 exchange may work to your benefit. If you intend to keep investing in real estate or using real estate in your trade or business, a Section 1031 exchange will maximize the capital you have available to reinvest.</span></p>
<h1 class="wp-block-heading"><b><i><span style="font-size: 12.0pt; color: #589199;">Key Elements of a Section 1031 Exchange*</span></i></b></h1>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;"> What is Section 1031? </span></h2>
<p><span style="font-size: 12.0pt;"> Section 1031 refers to Section 1031 of the Internal Revenue Code of 1986, as amended.</span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;"> What does it do? </span></h2>
<p><span style="font-size: 12.0pt;">Section 1031 permits a taxpayer (the Exchangor) to dispose of certain real estate and personal property and replace it with like-kind property without being required to pay taxes on the transaction.</span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;"> What property qualifies? </span></h2>
<p><span style="font-size: 12.0pt;">To qualify for a Section 1031 exchange, the property being disposed of (the Relinquished Property) must have been used in the Exchangor’s trade or business and/or must have been held for investment purposes. The property being acquired (the Replacement Property) must likewise be acquired for use in the Exchangor’s trade or business or for investment.</span><wp-block data-block="core/more"></wp-block></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;">What property is considered like-kind? </span></h2>
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<figure class="alignright size-full is-resized"><img data-recalc-dims="1" loading="lazy" decoding="async" width="1000" height="667" data-attachment-id="1869" data-permalink="http://harp-onthis.com/keys-rules-section-1031-exchanges/closeupwomancustomerreceivinghousekeyfromagentor/" data-orig-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/close-up-woman-customer-receiving-house-key-from-agent-or-realtor-after-finish-agreement-and-sign-contract.jpg?fit=1000%2C667" data-orig-size="1000,667" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"Shutterstock","camera":"","caption":"","created_timestamp":"0","copyright":"Copyright (c) 2018 Cat Box\/Shutterstock. No use without permission.","focal_length":"0","iso":"0","shutter_speed":"0","title":"Close,Up,Woman,Customer,Receiving,House,Key,From,Agent,Or","orientation":"1"}" data-image-title="Close,Up,Woman,Customer,Receiving,House,Key,From,Agent,Or" data-image-description="" data-image-caption="" data-medium-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/close-up-woman-customer-receiving-house-key-from-agent-or-realtor-after-finish-agreement-and-sign-contract.jpg?fit=300%2C200" data-large-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/close-up-woman-customer-receiving-house-key-from-agent-or-realtor-after-finish-agreement-and-sign-contract.jpg?fit=1000%2C667" src="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/close-up-woman-customer-receiving-house-key-from-agent-or-realtor-after-finish-agreement-and-sign-contract.jpg?resize=1000%2C667" alt="close up woman customer receiving house key from agent or realtor after finish agreement and sign contract" class="wp-image-1869" style="width:400px;height:267px" srcset="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/close-up-woman-customer-receiving-house-key-from-agent-or-realtor-after-finish-agreement-and-sign-contract.jpg?w=1000 1000w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/close-up-woman-customer-receiving-house-key-from-agent-or-realtor-after-finish-agreement-and-sign-contract.jpg?resize=300%2C200 300w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/close-up-woman-customer-receiving-house-key-from-agent-or-realtor-after-finish-agreement-and-sign-contract.jpg?resize=768%2C512 768w" sizes="auto, (max-width: 1000px) 100vw, 1000px" /></figure></div>
<p><span style="font-size: 12.0pt;">For real estate, to be like-kind means simply that real estate must be exchanged for real estate. The rules related to personal property are significantly more complex. </span><span style="font-size: 12.0pt;"><span style="font-size: 12.0pt;">Personal property is any property that is not real estate. </span></span></p>
<p><span style="font-size: 12.0pt;">Real estate exchanges are fairly straightforward. A warehouse may be exchanged for another warehouse or for any other qualifying real estate including, for instance, a factory building, office building, shopping center, single-tenant store, parking garage, or even a parcel of vacant ground so long as it qualifies as being acquired for use in the Exchangor’s trade or business or is to be held for investment. This is not a difficult test to pass. Similarly, a qualifying parcel of vacant ground or a shopping center or office building or factory or other parcels of investment real estate may be exchanged for any other qualifying real estate investment.</span></p>
<p>Personal property exchanges are not so straightforward. <span style="font-size: 12.0pt;">For personal property, the property must be substantially similar and of the same type or class. For example: a car can be exchanged for another car; and a bull can be exchanged for another bull; and a cow can be exchanged for another cow; but, a bull may not be exchanged for either a cow or a car. </span></p>
<p><span style="font-size: 12.0pt;">Although personal property exchange rules are substantially more technical and complicated than real property exchange rules, generally speaking, depreciable tangible personal property held for productive use in a trade or business can be exchanged for other depreciable tangible personal property held for productive use in a trade or business so long as they fall within the same NAICS classification code. </span></p>
<p><span style="font-size: 12.0pt;">For instance, Limited Service Restaurants such as fast food restaurants, pizza delivery, sandwich shops, etc. fall within 2012 NAICS Code 722513. Accordingly, the assets of one can be exchanged for the assets of the other under Section 1031. But, note that the NAICS Code for a bar, tavern or nightclub is 722410, and the NAICS Code for a full service restaurant is 722511, so an exchange of assets of either of these for the assets of the other, or the assets of a Limited Service Restaurant (even though otherwise physically identical), may not likely be considered “like kind”. </span></p>
<p><span style="font-size: 12.0pt;">The point, for purposes of this post, is that exchange rules for personal property are substantially more complex than exchange rules for real property. Accordingly, if you are exchanging personal property – either in conjunction with an exchange of real property or purely as a personal property exchange – great care must be taken to comply with the personal property exchange rules to receive the benefits of a tax deferred exchange under Section 1031.<br /></span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;">What property is excluded? </span></h2>
<p><span style="font-size: 12.0pt;">Some types of property are expressly excluded from tax deferred exchange treatment by statute, rule or regulation The following types of property <em>do not qualify</em> for aSection 1031 exchange: stocks, bonds, partnership interests, limited liability company interests, personal residences, stocks in trade or inventory, and certain other intangible property.</span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;">Are there timing issues? </span></h2>
<p><span style="font-size: 12.0pt;">Section 1031 exchanges can be simultaneous, but they are not required to be. In fact, most exchanges made pursuant to Section 1031 are not simultaneous. There are, however, strict timing rules that apply tonon-simultaneous exchanges and strict rules prohibiting access to funds.</span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;">What are the time limits? </span></h2>
<p><span style="font-size: 12.0pt;">The Replacement Property or properties must be identified, in writing, not later than forty-five days after the Relinquished Property is transferred (the Identification Period). The Replacement Property or properties must be acquired not later than the earlier of (i) 180 days after the Relinquished Property was transferred, or (ii) the due date for the Exchangor’s tax return, including any extensions (the Acquisition Period). The Identification Period is included within the Acquisition Period.</span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;">How many Replacement Properties may be identified? </span></h2>
<p><span style="font-size: 12.0pt;">There is no fixed limit to the number of Replacement Properties that may be identified, but there are two primary rules that apply: (1) the Three-Property Rule, and (2) the 200% Rule.</span></p>
<p><span style="font-size: 12.0pt;"> 1. The Three-Property Rule allows you to identify up to three (3) properties as potential Replacement Properties, regardless of value. You need not acquire all three properties, but as of the end of the Identification Period, not more than three properties may be identified. This is the most commonly used identification rule.</span></p>
<p><span style="font-size: 12.0pt;"> 2. The 200% Rule allows you to identify any number of potential Replacement Properties so long as the aggregate value of all identified properties does not exceed 200% of the value of the Relinquished Property. You need not acquire all identified properties.</span></p>
<p><span style="font-size: 12.0pt;">Generally, if you identify more properties than permitted, you are treated as if you have not identified any properties. However, there is one more rule that might save the day. The 95% Rule allows you to identify any number of potential Replacement Properties, regardless of value, so long as you <em>actually acquire</em> within the Acquisition Period at least 95% of the value of all properties identified. Use of the 95% Rule is rare, and is generally considered more a safety valve rule than an intentionally used exchange rule<br /></span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;"> Must all exchange proceeds be used? </span></h2>
<p><span style="font-size: 12.0pt;">There is no requirement that all proceeds received upon sale of the Relinquished Property be used to acquire the Replacement Property. Any exchange proceeds not used, however, are taxable.</span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;">What constitutes exchange proceeds? </span></h2>
<p><span style="font-size: 12.0pt;">Exchange proceeds means the net sale price of the Relinquished Property, including all net equity and the amount of any mortgage encumbering the Relinquished Property, whether paid off at closing or assumed by the purchaser. It is not sufficient to merely reinvest the net equity received upon sale. The purchase price of the Replacement Property must equal or exceed the aggregate of the net equity received upon sale of the RelinquishedProperty plus any mortgage encumbering the Relinquished Property at the time of the sale closing.</span></p>
<p><span style="font-size: 12.0pt;"><em>Example</em>: If the Relinquished Property is encumbered by a $700,000 mortgage and is sold for $1 million as part of a Section 1031 exchange transaction, to defer all taxes, the purchase price of the Replacement Property must be at least $1 million, not merely $300,000.</span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;">When can the Exchangor obtain access to unused proceeds? </span></h2>
<p><span style="font-size: 12.0pt;">Proceeds from sale of the Relinquished Property may be accessed only when the exchange is completed, fails, or expires. If no potential Replacement Properties are identified within the Identification Period, the exchange fails, and the Exchangor may receive the funds. Those funds will, however, be taxed in the year received. <em>But note</em>: If a mortgage was paid off at the Closing of the Relinquished Property, and the amount of the mortgage was greater than the tax basis of the Relinquished Property, the amount paid to satisfy the mortgage in excess of the tax basis of the Relinquished Property is taxable in the year of Closing of the Relinquished Property.</span></p>
<p><span style="font-size: 12.0pt;">If all properties identified within the Identification Period are acquired within the Acquisition Period, the exchange is completed, and any remaining funds may be received by the Exchangor. Those remaining funds are taxable. If less than all identified properties are acquired, but the Acquisition Period expires, all remaining funds may be received by the Exchangor, but are taxable.</span></p>
<h2 class="wp-block-heading"><span style="font-size: 12.0pt;">Conclusion:</span></h2>
<p><span style="font-size: 12.0pt;">These are the basics. As tax rates rise, Section 1031 exchanges become increasingly valuable.</span></p>
<p><span style="font-size: 12.0pt;">A Section 1031 exchange is not a new and exotic tax shelter scheme. Tax deferred exchanges of like-kind property have been recognized by the Internal Revenue Service as a valid tax deferral strategy since the early 1920s. The structure and effect of a Section 1031 exchange were specifically authorized by Congress by enacting Section 1031 of the Internal Revenue Code of 1986, as amended, and the Internal Revenue Service has promulgated extensive regulations for its implementation.</span></p>
<p><span style="font-size: 12.0pt;">Use Section 1031 to your advantage, but be sure to strictly comply with the Section 1031 rules.</span></p>
<p>* <em>Special Thanks to my tax partner, James M. Mainzer, for consulting on this post.</em></p>
<p><span style="font-size: 12.0pt;">_________________________________</span></p>
<p><i><span style="font-size: 12.0pt;">As required by the Internal Revenue Service under Circular 230, you are advised that any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this article.</span></i></p>
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<title>Section 1031 Like-Kind Exchanges – Part 1 of 3</title>
<link>http://harp-onthis.com/section-1031-like-kind-exchanges-part-1-of-3/</link>
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<dc:creator><![CDATA[Kymn Harp]]></dc:creator>
<pubDate>Tue, 22 Jul 2014 15:31:40 +0000</pubDate>
<category><![CDATA[Business]]></category>
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<description><![CDATA[This is the first installment of a three-part series on Section 1031 like-kind exchanges. Part 1 explains WHY you should consider use of a Section 1031 like-kind exchange when selling commercial or investment real property. Part 2 covers the key […]]]></description>
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<p><i>This is the first installment of a three-part series on Section 1031 like-kind exchanges. <b>Part 1</b> explains WHY you should consider use of a Section 1031 like-kind exchange when selling commercial or investment real property. Part 2 covers the key rules for HOW to implement a Section 1031 like-kind exchange. Part 3 covers special issues applicable to a Section 1031 like-kind exchange when a Tenant-In-Common [TIC] interest is being acquired.</i></p>
<h1 class="wp-block-heading"><b>Why Consider a §1031 Like-Kind Exchange? </b></h1>
<p>What if I told you that you could get a hefty 0% interest loan from the federal government to invest in commercial or industrial real estate? Would you be interested?</p>
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<figure class="alignleft"><a href="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2014/07/RSP.jpg"><img data-recalc-dims="1" loading="lazy" decoding="async" width="300" height="95" data-attachment-id="884" data-permalink="http://harp-onthis.com/section-1031-like-kind-exchanges-part-1-of-3/rsp/" data-orig-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2014/07/RSP.jpg?fit=334%2C106" data-orig-size="334,106" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":""}" data-image-title="RSP" data-image-description="" data-image-caption="" data-medium-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2014/07/RSP.jpg?fit=300%2C95" data-large-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2014/07/RSP.jpg?fit=334%2C106" src="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2014/07/RSP.jpg?resize=300%2C95" alt="RSP" class="wp-image-884" srcset="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2014/07/RSP.jpg?resize=300%2C95 300w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2014/07/RSP.jpg?w=334 334w" sizes="auto, (max-width: 300px) 100vw, 300px" /></a></figure></div>
<p>Better yet, what if that loan has no fixed monthly, quarterly, or annual repayment obligations and does not show up on your credit report or balance sheet as an outstanding liability?</p>
<p>Still better yet, what if the terms of the loan provide that it may never have to be repaid? Are you interested now?</p>
<p>In effect,* that’s what a Section 1031 like-kind exchange can do for you.</p>
<h2 class="wp-block-heading"><b>Here’s how:</b></h2>
<div class="wp-block-image">
<figure class="alignright size-full is-resized"><img data-recalc-dims="1" loading="lazy" decoding="async" data-attachment-id="1871" data-permalink="http://harp-onthis.com/section-1031-like-kind-exchanges-part-1-of-3/realestatetrading-businessmenagreetobuy-sellreal/" data-orig-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/businessman-exchanging-property.jpg?fit=1000%2C665" data-orig-size="1000,665" data-comments-opened="1" data-image-meta="{"aperture":"0","credit":"Shutterstock","camera":"","caption":"","created_timestamp":"0","copyright":"Copyright (c) 2019 Wasan Tita\/Shutterstock. No use without permission.","focal_length":"0","iso":"0","shutter_speed":"0","title":"Real,Estate,Trading.,Businessmen,Agree,To,Buy,-,Sell,Real","orientation":"1"}" data-image-title="Real,Estate,Trading.,Businessmen,Agree,To,Buy,-,Sell,Real" data-image-description="" data-image-caption="" data-medium-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/businessman-exchanging-property.jpg?fit=300%2C200" data-large-file="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/businessman-exchanging-property.jpg?fit=1000%2C665" src="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/businessman-exchanging-property.jpg?resize=400%2C266" alt="businessman exchanging property" class="wp-image-1871" width="400" height="266" srcset="https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/businessman-exchanging-property.jpg?w=1000 1000w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/businessman-exchanging-property.jpg?resize=300%2C200 300w, https://i0.wp.com/harp-onthis.com/wp-content/uploads/2023/03/businessman-exchanging-property.jpg?resize=768%2C511 768w" sizes="auto, (max-width: 400px) 100vw, 400px" /></figure></div>
<p>Section 1031 of the Internal Revenue Code permits </p>
<span id="more-578"></span>
<p>a taxpayer to dispose of property used in its trade or business or held for investment purposes without paying federal income taxes, including capital gains taxes, on any gain arising from the transaction. To qualify for nonrecognition of gain, the taxpayer disposing of the qualifying property must comply with the technical requirements of Section 1031 by exchanging the property for other like-kind property identified within 45 days after Closing, and acquiring the identified property within the time period provided by statute. In general, that time period is 180 days, but may be cut short if the taxpayer files its tax return for the period in which the Section 1031 like-kind exchange was initiated before the 180-day period expires. For real estate, “like-kind” generally means any other real estate, so long as it is acquired and held for use in your trade or business or for investment purposes. The key Section 1031 like-kind exchange rules are outlined later, in Part 2 of this series. This article addresses the advantages of a Section 1031 like-kind exchange.</p>
<p>To demonstrate the value of a Section 1031 like-kind exchange, let’s focus on the concept that a Section 1031 like-kind exchange permits you to dispose of qualifying property without being obligated to pay federal income taxes on any gain arising from the transaction. It works like this:</p>
<h2 class="wp-block-heading"><b>Scenario No. 1 </b></h2>
<p>Suppose you bought a parcel of vacant ground for $100,000, with the intent to use the parcel in your trade or business or simply to hold for investment purposes. A few years later, you decide to sell the parcel, which has risen in value to $300,000. Upon sale, you will have a taxable gain of $200,000.</p>
<p>Assume a federal capital gains tax rate of 20%. This is the current capital gains tax rate under the Internal Revenue Code.</p>
<p>At a 20% capital gains tax rate, the federal income tax payable in Scenario No. 1 is $40,000 (20% x $200,000 = $40,000). If you held the property free and clear, with no mortgage, you would be left with $260,000, which could, after payment of any applicable state taxes, be used to acquire another property ($300,000 sale price <i>less</i> $40,000 capital gains tax = $260,000).</p>
<p>States have their own taxes that may also be applicable. Illinois has a 5% flat tax on income. In Illinois, after applying the 20% federal capital gains tax rate and also applying the 5% Illinois flat tax rate, the effective rate on the gain is 25%. Accordingly, the effective tax on the $200,000 gain for an Illinois taxpayer would be $50,000, leaving only $250,000 available to reinvest. [Additionally, if that is not bad enough, you may also owe and additional 3.8% Medicare Surtax on net investment income.]
<h2 class="wp-block-heading"><b>Scenario No. 2 </b></h2>
<p>Suppose instead of purchasing a parcel of vacant property, as assumed in Scenario No. 1, you bought a parcel of improved real estate. Suppose the purchase price was $500,000, with $100,000 allocated to the land and $400,000 allocated to building improvements. Ten years later, you sell the property for $700,000. During the ten-year period you owned the property, you deducted $100,000 as depreciation expense.</p>
<p>Although the property is sold for $200,000 more than your purchase price, the gain you realize is actually $300,000 because the $100,000 accumulated depreciation deduction reduces the property’s tax basis by a corresponding amount. As a consequence, although you purchased the property for $500,000, the current tax basis (after depreciation) is only $400,000. Therefore, the taxable gain is $300,000, calculated by deducting the tax basis from the sale price.</p>
<p>At first glance, you may believe that the effect of the foregoing is to increase your capital gain to $300,000 resulting in a federal capital gains tax of $60,000 (20% x $300,000 = $60,000); but that is not correct. Under current tax law, you are required to first pay a tax on an amount equal to the accumulated depreciation taken as a deduction on the property, at a depreciation-recapture tax rate of 25%, with the balance of the gain taxed at the 20% federal capital gains rate. [Once again, you may also owe an additional 3.8% Medicare Surtax on net investment income.]
<p>As a consequence, the federal tax you will owe is (at least) $65,000, (25% x $100,000 depreciation-recapture tax = $25,000, plus 20% x $200,000 capital gain = $40,000, for a total federal tax of $65,000 – plus any additional 3.8% Medicare Surtax that may be applicable). If we once again assume for simplicity that you did not have a mortgage on the property, you would be left with $635,000 (or less) which, after payment of any applicable state tax on the gain, you could reinvest in another property. In Illinois you would pay an additional flat tax of $15,000 on the gain [$300,000 x 5% Illinois flat tax rate], leaving you only $620,000 (or less) to reinvest.</p>
<h1 class="wp-block-heading"><b>The Benefit of a Section 1031 Like-Kind Exchange</b></h1>
<p>The beauty of a Section 1031 like-kind exchange is that the gain on the transactions described in Scenario No. 1 and Scenario No. 2 is not recognized at the time of sale, with the result that you do not have to pay either the federal capital gains tax or the federal depreciation-recapture tax [and, in Illinois, you do not have to pay the 5% state flat tax] on the transaction. Likewise, any applicable 3.8% Medicare Surtax would be deferred as well. Consequently, in Scenario No. 1, you will have the whole $300,000 to reinvest; and in Scenario No. 2, you will have the whole $700,000 to reinvest (once again, assuming no mortgage).</p>
<p>The capital gains taxes and the depreciation-recapture taxes are not waived by use of a Section 1031 like-kind exchange but, rather, the obligation to pay these taxes is deferred until a future transaction that results in a taxable event that recognizes a gain. [The same is true with the Illinois flat tax and the Medicare surtax.]
<p>Since there is no prohibition against utilizing the Section 1031 like-kind exchange procedure in successive transactions, however, payment of taxes on the gain can be deferred indefinitely. If the taxpayer is a limited liability company, corporation, trust, or other entity with a perpetual existence, the day of reckoning for payment of the capital gains taxes and depreciation-recapture taxes [and state flat tax] may never come. You will, however, limit your depreciation deduction because the tax basis of the relinquished property will carry over as the tax basis of the replacement property. This tax basis can be adjusted upward if additional capital is contributed to acquire the replacement property or, thereafter, to improve the replacement property.</p>
<p>If the taxpayer/exchangor is a natural person rather than a limited liability company, corporation, trust, or other legal entity, the Internal Revenue Code provides that upon the death of the taxpayer/exchangor, the tax basis of all property owned by the taxpayer is adjusted to the property’s fair market value as of the date of death. As a consequence, no capital gains tax or depreciation-recapture taxes will ever be recognized on the prior exchanges. [In Illinois, the tax basis adjusts at death also, avoiding application of the state flat tax on the increase in value.]
<p>It is these attributes that form the basis of my statement at the outset of this article that it is possible to, in effect, obtain a long-term loan* from the federal government, without interest, without scheduled periodic payments, without reflecting an outstanding liability on your credit report or balance sheet, and, possibly, with no obligation to ever repay.</p>
[*As a fiscal conservative, I understand the argument that it is not <i>actually</i> like a “loan” because the money <i>actually</i> belongs to the taxpayer, not the government until taken via taxation. It may not be a perfect analogy, but you get the point.]
<p>There are strict technical rules that apply to Section 1031 like-kind exchanges. Among them are technical rules for exchanging property subject to a mortgage. For this reason, advice from a knowledgeable tax adviser is critical when structuring a Section 1031 like-kind exchange. In Part 2 of this series, entitled <i>Key Rules to Implementing a Section 1031 Like-Kind Exchange</i>, we will review the basic rules that apply to carrying out a Section 1031 like-kind exchange to obtain its advantages.</p>
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<p><i>As required by the Internal Revenue Service under Circular 230, you are advised that any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this article.</i></p>
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