Is your business buying and selling property on a regular basis? Are you paying tax with every sale that results in a gain? If so, you may want to consider a like-kind exchange!
In general, all gains and losses realized on sales and other dispositions of property are taxable, but an exception is made when business or investment property is traded or exchanged for “like-kind” property. In this case, the newly acquired property is viewed as a continuation of the investment in the original property, so the tax basis does not change. The reason to make the tax free exchanges is not to avoid taxes, but to defer them while realizing some other investment aims.
Generally, if you exchange business or investment property solely for business or investment property of a like-kind, no gain or loss is recognized under Internal Revenue Code Section 1031. However, if as part of the exchange, you also receive other (not like-kind) property or money, a gain is recognized to the extent of the other property and money received, but a loss is not recognized.
Properties are of like-kind, if they are of the same nature or character, even if they differ in grade or quality. Personal properties of a like class are like-kind properties. Real properties generally are of like-kind, regardless of whether the properties are improved or unimproved. Property held for productive use in a trade or business may be exchanged for property held for investment. Some examples of like kind exchanges include: exchanging improved for unimproved real estate and exchanging a used car for a new one.
Real property in the United States and real property outside the United States are not like-kind properties. Personal property used predominantly in the United States and personal property used predominantly outside the United States are also not like-kind properties. Furthermore, Section 1031 does not apply to exchanges of inventory, stocks, bonds, notes, other securities or evidence of indebtedness, or certain other assets.
Like-kind exchanges are a useful planning tool in deferring tax on appreciated property if you intend to reinvest in a similar property within a relatively short period of time. No gain or loss is recognized in a deferred like-kind exchange if you meet the following requirements:
1) You must follow specific procedures to identify replacement property within 45 days after relinquishing the old property.
2) You must receive the replacement property within 180 days after relinquishing the old property or by the due date of your tax return for the year in which you transferred the property given up, whichever is earlier.
Say you trade an old truck used in your business with an adjusted basis of $5,000 for a new one costing $50,000. The dealer allows you $20,000 on the old truck and you pay the remaining $30,000. This is a like-kind exchange. Your basis in the new truck is $35,000 (the adjusted basis in the old truck plus the amount you paid). Furthermore, you can defer the tax on the $15,000 gain. At a capital gains rate of 15%, this exchange enables you to defer over $2,250 in taxes!
So if you find yourself buying and selling a lot of property for your business, it is in your best interest to consider like-kind exchanges. With a little upfront planning, you can significantly reduce your tax bill and improve your bottom line!
Please let us know if you have questions concerning like-kind exchanges or any related concepts, we can be reached at (480) 980-3977!