1031 Like-Kind Exchange- What Does That Mean?
Like-Kind Exchanges (LKEs) are tax-advantaged vehicles that provide an efficient way to defer the tax on gains from the sale of real or personal property when replaced with Like-Kind property. Internal Revenue Code Section 1031offers a "safe harbor" to taxpayers (Exchangors) that use a Qualified Intermediary (QI). A QI is an independent third party charged with holding the Exchangor's funds during the period between disposition of property (Relinquished Property) and acquisition of property (Replacement Property).
The rules for an LKE are straightforward and very important. A valid LKE requires in part that:
The property must held be for investment purposes or for productive use in business. Therefore, LKE treatment is not available to dealers selling inventory.
The Exchangor may not receive the cash proceeds from the sale. To avoid actual or constructive receipt, funds are held in an exchange account during the exchange period.
Legal documents required include an Exchange Agreement as well as certain assignments and notices prior to closing.
To fully defer the capital gains tax or recapture, the Replacement Property should be of equal or greater value to the Relinquished Property and have equal or greater equity and debt.
The Exchangor, within 45 calendar days from the disposition of the Relinquished Property, must clearly and unambiguously identify up to three potential Replacement Properties.
The Exchangor may identify more than three properties so long as their combined fair market value does not exceed 200% of the value of the Relinquished Property.
The Exchangor may exceed the 200% limitation, only if it then acquires 95% of the fair market value of the properties identified to fulfill the requirements of Section 1031.
Within 180 calendar days from the date of the transfer of the Relinquished Property, the Exchangor must acquire one or more identified Replacement Properties.
Each Replacement Property must be "Like-Kind" to the Relinquished Property. In general, real property held for investment purposes or for productive use in business is like-kind to other real property.
For more specifics on 1031 Like-Kind Exchanges, please speak with your accountant. Its very important to speak with your accountant for any major financial decisions.