In light of the new 2018 tax bill, we’re taking a look at Section 1031 of the IRS Code. This will provide a refresher of information on what 1031 or like-kind exchanges are, and how they work. In the 2018 tax bill, no changes have been made to the like-kind exchange. Investment property owners will continue to be able to defer capital gains taxes using 1031 tax-deferred exchanges, which have been in the tax code since 1921. No new restrictions on 1031 exchanges of real property were made in the 2018 tax law. However, the tax law repeals 1031 exchanges for all other types of property that are not real property. This means 1031 exchanges of personal property such as: business assets, aircraft, artwork, coin collections, construction equipment, and fleets of autos or trucks will no longer be permitted as of January 1, 2018.
What is a 1031 Exchange?
A 1031 Exchange is a transaction in which a taxpayer is allowed to exchange one investment property for another (like-kind), and deferring the tax consequence of a sale. To be considered “like-kind” the property must be in the same nature and character, even if they differ in grade or quality. The transaction is authorized by Section 1031 of the IRS Code. IRC Section 1031 allows an investor to postpone paying tax on the gain if they reinvest the proceeds in similar property, as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free. Savings in a 1031 exchange are considered “deferred” because you’ll eventually pay a capital gains tax, depreciation recapture, and state taxes if you sell the new property. However, investors can avoid these taxes indefinitely if they don’t sell, or if the like-kind exchange is used again.
Timelines for a 1031 Exchange
While a like-kind exchange does not have to be a simultaneous swap of properties, the investor must meet two time limits or the entire gain will be taxable. These limits cannot be extended for any circumstance or hardship except in the case of presidentially declared disasters. The investor must follow the strict 45/ 180-day guidelines for an exchange. Once the investor sells their property they have 45 days to identify property of equal or greater value. The identification must be in writing, signed, and delivered to a person involved in the exchange, like the seller of the replacement property or the qualified intermediary. Once identified, the investor then has 180 days from the day they sold their property, to acquire the property identified (or 135 days from the end of the 45-day period). In short, the new property has to be identified within 45 days of the initial sale and purchased within 180 days of the sale.
How is a 1031 Exchange Reported?
The exchange must be reported to the IRS using Form 8824 “Like-Kind Exchanges” and filed with the tax return for the year in which the exchange occurred. The form requires the following information: descriptions of the properties exchanged, dates that properties were identified and transferred, any relationship between the parties to the exchange, value of the like-kind and other property received, gain or loss on sale of other (non-like-kind) property given up, cash received or paid; liabilities relieved or assumed, adjusted basis of like-kind property given up; and realized gain. If the investor does not specifically follow the rules for like-kind exchanges, they may be held liable for taxes, penalties, and interest on the transactions.