Generally, when a person sells business or investment property, he or she must pay taxes on the gain of the sale. However, IRC Section 1031 allows an exception to paying this tax in the form of a deferred like-kind exchange. This exchange allows you to postpone paying the tax, so long as you reinvest the proceeds into a similar property, as part of a like-kind exchange. It is important to know that gain-deferred is tax-deferred, but not tax-free.
A deferred like-kind exchange allows a property owner to let go of an investment, trade or business property they own in order to acquire another property for use in a trade or business or for investment purposes. In doing so, capital gains tax is deferred until the replacement property is sold.
The relinquishment of property and the acquisition of new property must be mutually dependent components of an exchange of property transaction. Usually, taxpayers who wish to engage in this type of exchange will use exchange facilitators pursuant to rules that are outlined in the Income Tax Regulations.
There are two time limits to complete a Section 1031 deferred like-kind exchange:
- The property owner has 45 days from the date he or she sold the relinquished property to find and identify a replacement property. It must be in writing, signed, and delivered to someone involved in the exchange, such as a qualified intermediary or the seller of the replacement property.
- The replacement property must be received and the exchange completed no more than 180 days post-sale of the exchanged property, or the due date (including extensions) of the income tax return for the tax year that the property was sold, whichever is earlier. Importantly, the replacement property must be quite similar to the property that was identified in the first aforementioned time limit (45 days).
What Does “Identify” Mean?
As previously discussed, in a like-kind exchange, replacement property is “identified” when it is found and identified by the taxpayer within 45 days after he or she relinquishes their property.
To identify the replacement property, the individual must designate the property as such in a signed, written agreement and deliver the document to the individual who is transferring the property or any other person involved in the exchange (not including the taxpayer’s agents). The property must also be meticulously described within the written agreement
What Qualifies as a Deferred Like-Kind Exchange?
To qualify for a deferred like-kind exchange, a taxpayer cannot sell their property for cash, and go on to use that cash to buy a replacement property. This would be considered a sale, and would exclude the taxpayer from qualifying for a like-kind exchange. Similarly, if a taxpayer has a receipt for the full amount of the relinquished property before the exchange is completed, they too, would be excluded from the tax benefits of a like-kind exchange.
Do I Need an Attorney to Help Me with My Tax Problems?
If you have any questions regarding tax laws, you should contact a qualified tax attorney. A local tax lawyer will be able to provide knowledge and guidance to better help you navigate tax laws, and save you money in the process. If need be, your attorney will also be able to represent you before the IRS, and provide peace of mind and confidence in your property transactions.