When a taxpayer exchanges property for a gain or a loss, it is usually recognized and reported on the taxpayer’s tax return as income or deduction in the year of the exchange. There are, however, exceptions to this general rule. One notable example is the nonrecognition of gain and loss for like-kind exchanges.
What Is a Like-Kind Exchange?
A like-kind exchange basically is an exchange of property held for productive use in a trade or business or for investment solely for property of "like-kind" which is to be held for productive use in a trade or business or for investment. Thus, a property held for personal use (e.g. personal residence) in exchange for a property for business use will not qualify for like-kind exchange treatment.
What Is Property of “Like-Kind”?
"Like-Kind" is a pretty broad concept under the tax law. Ordinarily, property is of "like-kind" if it has the same nature or character as the property exchanged out by the taxpayer. Most real property is of "like-kind" to other real property. For example, a vacant lot is of "like-kind" to a 30-floor apartment building. On the other hand, personal property is generally of "like-kind" to similar kinds of property, like a computer to a computer printer. Yet, a truck is not of "like-kind" to a computer.
There is a list of properties that the law precludes from being of "like-kind":
- Real property located in the United States for real property located outside of the United States
- Personal property used predominantly within the United States for personal property used predominantly outside of the United State
- Livestock of different sexes
- Stocks in trade or other property held primarily for sale
- Stocks, bonds, or notes
- Other securities or evidences of indebtedness or interest
- Interest in a partnership
- Certificates of trust or beneficial interests
- Choses in actions (a right to receive or recover income, other consideration, or property from another)
What Are Some Benefits of Entering into a Like-Kind Exchange?
The main benefit of a like-kind exchange is that the taxpayer does not need to recognize any income currently if he or she exchanged property at a gain. Yet the amount of gain that is not recognized will be used to lower the basis of the property received. Thus, when the taxpayer later sells the new property to another party, he or she may be taxed on gain if the sale price is greater than the basis.
Another benefit of a like-kind exchange is that the taxpayer may be able to exchange non-depreciable property, such as land, for depreciable property, such as a building and to generate depreciation expense deductions to offset income.
What Is the Downside of Entering into a Like-Kind Exchange?
When an exchange qualifies as a like-kind exchange, both gain and loss do not get recognized. So if a taxpayer exchanged property at a loss, then that loss may not be recognized and deducted currently. However, the taxpayer can increase the basis of the property received by the amount of loss not recognized and can potentially deduct the loss if he or she later sells the property to an unrelated party for a prize lower than the basis.
What If I Paid or Received Cash Along with the Exchange?
Usually, there is no tax consequence to the taxpayer who paid cash along with the exchange. However, if the taxpayer received cash with the exchange, then the gain from the exchange will generally be recognized as income to the extent of cash received.
Do I Need an Attorney to Help Me with My Tax Problems?
Tax laws are complex and ever-changing. Although there are various tax preparation softwares on the market that may help you with your tax problems, they cannot provide the same level of service that an experienced and knowledgeable tax attorney can. If you are unsure whether an exchange qualifies as a like-kind exchange or you need someone to represent you before the IRS, a tax attorney can help you.