August 28, 2020
Like-kind exchanges are nothing new. Since 1921, the provisions outlined in the section of the United States Tax Code, known as “1031” have allowed taxpayers to defer taxes on certain assets. The caveat to this benefit is that earnings derived from the sale of the asset must be invested in another, similar asset.
The benefits derived from the like-kind (or 1031) exchange have made them widely popular in capital-intensive industries like farming, mining, car rental companies, and commercial real estate. As long as an investor buys a replacement property of the same value, or more, within a given time, he is shielded from paying capital gains tax until the replacement property is sold. However, it should be noted that an investor can repeatedly do 1031 exchanges until ultimately “cashing out.”
Like-kind exchanges have come under some scrutiny in recent years. Much of the scrutiny began in 2014 when the Congressional Joint Committee on Taxation (JCT) presented evidence that over ten years, a nearly $40 billion tax-revenue gain could be realized through the repeal of 1031. President Obama proposed a $1 million cap on 1031 tax savings and then proposed further restrictions two years later. Even the current administration under President Trump has put their fingerprint on Code 1031.
Per the IRS’s website, “Under the Tax Cuts and Jobs Act, Section 1031 now applies only to exchanges of real property and not to exchanges of personal or intangible property. An exchange of real property held primarily for sale still does not qualify as a like-kind exchange.” That means that exchanges centered on personal aircraft, machinery, equipment, and vehicles no longer qualify for non-recognition of gain or loss as like-kind exchanges. Real property is primarily land and any property attached directly to it. So, despite the latest restrictions, like-kind exchanges can still present a real opportunity for real estate investors.
There are some pretty rigid rules surrounding 1031 exchanges, like using a qualified intermediary to facilitate the exchange. There are time constraints, and investors must also be sure of exchanging properties of the same nature or character. Fortunately, real properties generally are of like-kind, regardless of whether they’re improved or unimproved. Despite the hurdles, the benefits to an investor can be significant, including:
- Deferral of capital gains taxes
- Acquisition of a property with better returns
- Consolidation of properties into a single property
- Resetting depreciation.
So, yes, 1031 exchanges are still a thing. They can also offer immense benefits. While they can be tricky to execute, even for savvy investors, an experienced real estate firm can appropriately guide you through the exchange process.
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