by Michael E. Rubin, Esq.
If you are contemplating selling appreciated property held for investment or business purposes and acquiring a similar replacement property, you should consider whether you qualify for a tax deferral strategy called a “like-kind exchange.”
Section 1031 of the Internal Revenue Code allows taxpayers to defer the recognition of gain or loss on the exchange of property that is held for productive use in a trade or business or for investment for property of a “like kind” that is also held for productive use in a trade or business or for investment.
Who qualifies for a like-kind exchange?
Individuals, C corporations, S corporations, partnerships, limited liability companies, trusts and any other taxpaying entity may take advantage of Section 1031.
What property qualifies for a like-kind exchange?
The property you sell and the property you buy must meet certain requirements. Both properties must be held for use in a trade or business or for investment.
Both properties must be similar enough to qualify as "like-kind." Like-kind property is property of the same nature, character or class. Quality or grade does not matter. 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. In personal property exchanges, the rules pertaining to what qualifies as like-kind are more restrictive than the rules pertaining to real property. For example, cars are not like-kind to trucks.
Certain types of property are specifically excluded from Section 1031 treatment. Section 1031 does not apply to exchanges of:
- Inventory or stock in trade;
- Stocks, bonds, or notes;
- Other securities or debt;
- Partnership interests; and
- Beneficial interests in trusts.
Whether property is held for productive use in a trade or business or for investment is determined at the time of the exchange.
What are the different structures of a like-kind exchange?
To accomplish a like-kind exchange, there must be an exchange of properties. The simplest type of exchange is a simultaneous swap of one property for another. However, under a deferred exchange, you may dispose of property and subsequently acquire a like-kind replacement property. A deferred exchange must be executed properly and meet the strict requirements of Section 1031. The disposition of the relinquished property and acquisition of the replacement property must be mutually dependent parts of an integrated transaction constituting an exchange of property within the time limits prescribed in Section 1031.
If you are considering a like-kind exchange, you should work with a qualified professional who is familiar with the many requirements of Section 1031.
Michael E. Rubin, Esq. is a partner with the corporate and real estate practice group of Posternak Blankstein & Lund LLP in Boston. He regularly advises investors and business owners on mergers, acquisitions, sales and transfers of businesses of all types, but especially closely- and family-held businesses. He can be reached at 617-973-6110 and at firstname.lastname@example.org.