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Trading Places: Make Your Move Now

(posted: May 29th, 2015)


Now may be the time for savvy real estate investors to make a move.

Strategy: Trade property you own for a "like-kind" property. As long as you meet all the current tax law requirements, you can defer any appreciation in value built up over the years until you sell the replacement property, if ever. By using this technique, real estate owners literally defer tax on billions of dollars each year.


Here's the Whole Story

Under Section 1031 of the tax code, an individual can defer taxable gains when exchanging properties that are similar in nature, except to the extent that he or she receives cash or other "boot" as part of the transaction. In that case, you must pay current tax on the gain up to the amount of boot received. Otherwise, no tax is owed until you sell the newly acquired property.

To qualify as a like-kind exchange, both the property being relinquished and the property being acquired must be investment or business property. You can't swap personal property tax-free under Section 1031. "Like-kind" refers to the property's nature or character. Tax regulations provide a liberal interpretation of this standard.

Examples: Someone can exchange improved real estate for raw land, a shopping mall strip for an apartment building, a marina for a golf course. But you can't swap real estate for personal-property assets such as equipment or vehicles.

The vast majority of high-priced Section 1031 exchanges involve swaps of investment real estate properties. Typically, multiple parties are involved.

It is better to give than receive

When properties of differing values are exchanged, one party to the transaction often adds boot to even out the deal. Boot can take the form of cash or dissimilar property, or a mixture of both. If you receive boot, you owe current tax on the amount equal to the lesser of:

  • The realized gain (i.e., the difference between the basis of the property being given up and the fair market value of what is received in exchange, including any boot)
  • The fair market value of the boot.

On the other hand, if you're the one paying the boot, you don't realize any taxable gain.

Timing is everything

A taxpayer must meet the following two deadlines to qualify for tax deferral on a like-kind exchange:

  1. You must identify (or actually receive) the replacement property within 45 days of transferring legal ownership of the relinquished property.
  2. The title to the replacement property must be transferred to you within the earlier of 180 days or your tax return due date, plus extensions, for the tax year of the transfer.

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