On November 19th, the IRS issued IR-2018-227, reminding taxpayers that Like-Kind exchange tax treatment is now generally limited to exchanges in real property that is held for use in a trade or business or for investment. Real property includes land and generally anything built on or attached to it. An exchange of real property held primarily for sale still does not qualify as a Like-Kind exchange.
Pursuant to the Tax Cuts and Jobs Act, effective Jan. 1, 2018, exchanges of personal or intangible property such as machinery, equipment, vehicles, artwork, collectibles, patents, and other intellectual property generally do not qualify for nonrecognition of gain or loss as Like-Kind exchanges. However, certain exchanges of mutual ditch, reservoir or irrigation stock are still eligible. In addition, a transition rule in the new law allows Like-Kind treatment for some exchanges of personal or intangible property. If the taxpayer disposed of the personal or intangible property on or before Dec. 31, 2017, or received replacement property on or before that date, the exchange may qualify for Like-Kind exchange treatment.
Like-Kind exchanges are governed by Internal Revenue Code Section 1031 which states that “ no gain or loss shall be recognized on the exchange of property held for productive use in a trade of business or for investment if such property is exchange solely for property of like kind which is to be held either for productive use in a trade or business or for investment”. In order to qualify for Like-Kind exchange treatment, a transaction must meet several requirements. First, the exchanged property and replacement property must be held for investment or use in a trade or business. Second, in a Forward Exchange the proceeds from the sale of the exchanged property must be “parked” with a Qualified Intermediary (QI) pending identification and purchase of the replacement property. Third, the taxpayer has 45 days from the date of sale of the exchanged property to identify potential properties to be the replacement property. Fourth, the taxpayer has 180 days from the date of the sale of the exchanged property to complete the purchase of the replacement property. Finally, the exchanged property and replacement property must be “like kind”. “Like kind” refers to “ the nature of character of the property and not to its grade or quality”. Treasury Regulation § 1.1031(a)-1(b).
A “Reverse Exchange” is the opposite of a Forward Exchange and involves a taxpayer purchasing the replacement property and subsequently identifying and selling the exchanged property. IRS Revenue Procedure 2000-37 provides a safe harbor under which the IRS will not challenge a Reverse Exchange as long as (1) the replacement property and exchanged property are held for investment or use in a trade or business, (2) the taxpayer identifies the exchanged property within 45 days of the purchase of the replacement property, (3) the taxpayer sells the exchanged property no more than 180 days after the replacement property was purchased and (4) the replacement property and the exchanged property are like kind. In addition, the taxpayer cannot be the holder of the replacement property until the sale of the exchanged property is closed. While the sale of the exchanged property is pending the replacement property is transferred to an Exchange Accommodation Titleholder (EAT) which holds the replacement property until the sale of the exchanged property is completed. No later than five business days after the transfer of the property to the EAT, there must be a written Qualified Exchange Accommodation Agreement.
In both a Forward Exchange and a Reverse Exchange a taxpayer’s basis in the new replacement property is the same basis as the exchanged property, adjusted for any other property given or received in the exchange. To report a Like-Kind exchange, taxpayers must file Form 8824, Like-Kind Exchanges, with their tax return for the year the taxpayer transfers property as part of a Like-Kind exchange.
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