The exchange of property for the same kind of property is the most common type of non-taxable exchange. To be a like-kind exchange, the property traded and the property received must be both of the following:
Additional requirements apply to exchanges in which the property received is not received immediately upon the transfer of the property given up. These are known as Deferred Like-Kind Exchanges, and are the more common type.
If the like-kind exchange involves the receipt of money, or unlike property, or the assumption of liabilities, then some of the gain may have to be recognized. This is often known as a Partially Non-taxable Exchange, and the excess proceeds are often known as boot.
When you acquire property in a like-kind exchange, the tax cost basis of that property is the same as the basis in the property that was transferred away. In the case of a partially non-taxable exchange, the basis in the new property is usually adjusted as a result of the taxable portion of the transfer.
If, in addition to giving up like-kind property, you need to pay money as part of the like-kind exchange transaction, you still have no recognized gain or loss. However, the basis in the property received is the basis of the property given up, increased by the amount of money paid.
Exchange expenses are generally the closing costs that you pay - including such items as brokerage commissions, attorney fees, intermediary fees, deed preparation and registration fees, and transfer taxes. Subtract these fees from the consideration received to determine the amount realized on the exchange. Also, add them to the basis of the property received. If you receive cash or unlike property in addition to the like-kind property and realize a partial or full gain on the exchange, subtract the expenses from the cash or the fair market value of the unlike property - and so use the net figure to calculate the gain that will be subject to tax.
In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in a trade or business. Buildings, land, and rental houses are typical examples of property that may qualify for like-kind treatment.
following specifically do not qualify:
Machinery, equipment, and vehicles
Property used for personal purposes, such
as home or cars
Stocks, bonds, securities, debt instruments, receivables
Certificates of trust or beneficial interests in trusts
Stock in trade, inventories, raw materials held for
Real estate held by dealers or developers for sale
Business interests - depends on individual assets
within the business
properties are properties of the same nature or character,
even if they differ in grade or quality. The exchange of real estate for real estate, is an exchange of like-kind property. For example, the exchange of land improved with an apartment building for land improved with a store building is a like-kind exchange.
exchange of personal property for real property, or
vice versa, does not qualify as a like-kind exchange.
exchange of city property for farm/rural property,
or improved property for unimproved property, can
be a like-kind exchange.
exchange of real estate for a real estate lease that
runs 30 years or longer can be a like-kind exchange.
However, this area can be complicated, as not all
exchanges of interests in real property will qualify.
For example, an exchange of a life estate for a remainder
interest usually will not qualify. But note, an exchange
of a remainder interest in one real estate for a remainder
interest in another real estate, if the nature or
character of the two property interests is the same,
estate located outside of the United States is generally
not considered like-kind property under these rules.
If you exchange foreign real property for property
located in the United States, your gain or loss on
the exchange will be recognized. There may be some
limited exceptions for condemned real property.
Deferred Exchange Issues
deferred exchange is one in which you transfer property
and later receive the replacement property - and is
the more common method of like-kind exchanges involving
real estate. The transaction must be an exchange,
and cannot be a transfer of property for money used
to buy the replacement property.
note: if, before you receive the replacement property,
you actually or constructively receive money or unlike
property in full payment for the property you transfer,
then the transaction will be treated as a sale and
the gain will be taxable - even if you later receive
the replacement property, which would then be treated
as a purchase.
constructively receive money or unlike property when
the money or property is credited to your account
or made available to you. You also constructively
receive money or unlike property when any limits or
restrictions on it expire or are waived. This issue
needs to be monitored carefully to ensure that no
inadvertent violation occurs.
you actually or constructively receive money or unlike
property, however, it is determined without regard
to certain arrangements you may make to ensure that
the other party carries out its obligation to transfer
the replacement property to you. For example, if you
have that obligation secured by a mortgage, or by
cash held in a qualified trust or escrow account,
that arrangement will be disregarded in determining
whether you actually or constructively received any
monies or unlike property.
of the significant pitfalls inherent with deferred
exchanges, the use of a Qualified Intermediary provides
a safety net against like-kind exchanges failing because
of the cumbersome steps needed in coordinating the
Qualified Intermediary is a person who enters into
a written exchange agreement with you to acquire and
transfer the property you give up, and to acquire
the replacement property and transfer it to you. This
agreement must expressly limit your rights to receive,
pledge, borrow, or otherwise obtain the benefits of
the money or other property held by the Qualified
you transfer property through a Qualified Intermediary,
the transfer of the property given up and the receipt
of the like-kind property are treated as an exchange.
following cannot be a Qualified Intermediary:
agent at the time of the transaction.
person who has been your employee, attorney, accountant,
investment banker, broker, or real estate agent
within the two year period before the transfer of
the property that you give up.
person that is a related party to you or to your
Qualified Intermediary is treated as acquiring and
transferring property if all of the following requirements
intermediary acquires and transfers legal title
to the property.
intermediary enters into an agreement with a person
other than you for the transfer to that person of
the property you give up, and that property is transferred
to that person.
intermediary enters into an agreement with the owner
of the replacement property for the transfer of
that property, and that replacement property is
transferred to you.
intermediary is treated as entering into an agreement
if the rights of a party to the agreement (your
rights) are assigned to the intermediary and all
parties to that agreement are notified in writing
of the assignment by the date of the relevant transfer
of the property.
must identify to the Qualified Intermediary the property
to be received within 45 days after the date that
you transfer the property given up in the exchange
- which is the date that the property has been assigned
to the Qualified Intermediary. Any property actually
received during that 45 day period is considered to
be de facto identified.
you transfer more than one property as part of the
same transaction, and the properties are transferred
on different dates, the identification period and
the receipt period begin on the date of the earliest
must identify the replacement property in a signed
written document and deliver it to the Qualified Intermediary
involved in the exchange. You must clearly describe
the replacement property in the written document.
For example, use the legal description and street
address for real estate. In the same manner, you can
cancel an identification of replacement property at
any time before the end of the identification period.
can identify more than one replacement property. Regardless
of the number of properties that you give up, the
maximum number of replacement properties that you
can identify is the larger of the following:
number of properties whose total fair market value
at the end of the identification period is not more
than double the total fair market value, on the
date of transfer, of all the properties that you
the replacement property has not yet been produced
or built at the time of identification, it may still
qualify as a like-kind exchange, but there are complex
rules that will need to be observed and followed.
replacement property or properties must be received
by the earlier of the following dates:
The 180th day after the date on which you transfer
the property given up in the exchange. If more than
one property was given up, then it is the 180th
day after the earliest transfer. Please note that
180 days is NOT six months, and must be measured
to the day.
due date, including extensions, for your tax return
for the year in which the transfer of the property
given up occurs. For transfers occurring in the
last few months of any calendar year, it may be
prudent to extend the filing of a tax return in
order to ensure the full 180 days are available,
are other possibilities to complete like-kind exchanges
using Qualified Exchange Accommodation Arrangements,
but these are beyond the scope of this general summary.
Also, the rules for multiple property exchanges, partially
non-taxable exchanges, and limited related party exchanges,
are extensive and rather technical. Specific advice
should be sought if contemplating one of the more
esoteric like-kind transactions.
Pragmatic Procedural Steps
finds a buyer for a property, negotiates a sale,
and signs a purchase and sale agreement to sell
to the prospective purchaser.
Taxpayer enters an exchange agreement with a Qualified
Taxpayer assigns the Purchase and Sale agreement
to the Qualified Intermediary. This starts the 45
day and 180 day periods.
Intermediary notifies all parties in writing of
the assignment, and advises the Taxpayer of the
deadline for identifying the replacement property
Intermediary closes on the sale as appropriate and
retains control of the funds pending acquisition
of the replacement property.
identifies replacement property, negotiates acquisition
terms and price, and notifies Qualified Intermediary
thereof within the 45 day identification period.
Intermediary enters into an agreement with the owner
of the replacement property to complete the transfer
of the property to the Taxpayer.
replacement property is actually transferred within
the replacement period of 180 days.
(The information in this article is a summary and should not be
viewed as a substitute for the law and/or the regulations.)