Tax Tip for July 2001
Like-kind
exchanges, general rules
You might be able to dispose of
appreciated property without being taxed on the gain by exchanging it rather
than selling it. You can defer tax on your gain through the “like-kind”
exchange rules.
A like-kind exchange is any
exchange (1) of property held for investment or for productive use in your trade
or business for (2) like-kind investment property or trade or business property.
For these purposes, “like-kind” is very broadly defined. As long as the
exchange is real estate (land and/or buildings) for real estate, or personally
(non-real estate) for personally, it should qualify. However, exchanges of some
types of property (for example, inventory or shares of stock), do not qualify.
If you are unsure whether the property involved in your exchange is eligible for
a tax-free like-kind exchange, please call and we can discuss the matter.
Assuming the exchange qualifies,
here's how the tax rules work:
If it's a straight asset-for-asset
exchange, you will not have to recognize any gain from the exchange. You will
take the same “basis” (your cost for tax purposes) in your new property that
you had in the old property. Even if you do not have to recognize any gain on
the exchange, you still have to report the exchange on Form 8824.
Frequently, however, the
properties are not equal in value, so some cash or other (non- like-kind)
property is tossed into the deal. This cash or other property is known as
“boot.” If boot is involved, you will have to recognize your gain, but only
up to the amount of boot you receive in the exchange. In these situations, the
basis you get in the like- kind property you receive is equal to the basis you
had in the property you gave up reduced by the amount of boot you received but
increased by the amount of gain recognized.
Example. Ted exchanges land
(investment property) with a basis of $100,000 for a building (investment
property) valued at $120,000 plus $15,000 in cash. Ted's gain on the exchange is
$35,000: he received $135,000 in value for an asset with a basis of $100,000.
However, since it's a like-kind exchange, he only has to recognize $15,000 of
his gain: the amount of cash (boot) he received. Ted's basis in his new building
will be $100,000: his original basis in the land he gave up ($100,000) plus the
$15,000 gain recognized, minus the $15,000 boot received.
Note that no matter how much boot
is received, you will never recognize more than your actual (“realized”)
gain on the exchange.
If the property you are exchanging
is subject to debt from which you are being relieved, the amount of the debt is
treated as boot. The theory is that if someone takes over your debt, it's
equivalent to his giving you cash. Of course, if the property you are receiving
is also subject to debt, then you are only treated as receiving boot to the
extent of your “net debt relief” (the amount by which the debt you become
free of exceeds the debt you pick up).
Like-kind exchanges are an
excellent tax-deferred way to dispose of investment or trade or business assets.
If you have additional questions or would like to discuss the topic further,
please call.
