It’s no secret that the Tax Cuts and Jobs Act (TCJA) ushered in sweeping changes to tax law that affected all of us. Today we’ll be talking about one such effect on owners of real estate: the 1031 exchange. Also known as like-kind exchanges, 1031 exchanges have been around for decades, enabling individuals and businesses to defer gains when personal or real property was exchanged for another similar property. If properly completed, this strategy offers significant tax advantages.
First, a quick overview of how 1031 exchanges work. Often these exchanges can be very complex, so we’ll just look at the general rules for illustrative purposes. Like-kind exchanges allow you to sell a business or investment property and reinvest the proceeds in a similar (i.e. Like-Kind) property of equal or greater value, thereby deferring capital gains tax on the original sale. Regulations stipulate the taxpayer must identify the replacement property within 45 days of the original sale. Once the original property is sold, the taxpayer will then have 180 days to complete the purchase of the replacement property. The proceeds from the original sale effectively become the down payment for the replacement property. To meet the 1031 requirements, the cash received from the sale must be reinvested in the replacement property. There are many other requirements that must be met to ensure you meet the requirements for like-kind deferral treatment so a qualified intermediary is recommended to assist in the transaction.
As you can see, the tax advantages of a like-kind exchange can be substantial. However, with the passage of TCJA, Congress repealed all personal and intangible property exchanges, which means no more tax deferral on vehicles, machinery, equipment, livestock, artwork, and patents. This changes the taxability of the trade-in for automobiles that were previously eligible for 1031 deferral. Therefore, when you trade-in a business vehicle or machinery there is no longer a deferral option so be sure to check with your tax advisor if you are considering a vehicle trade-in.
That said, real property that is not held primarily for sale still qualifies for the same treatment as under the previous law. Although the new law eliminated one aspect of 1031 exchanges, those involving real property will continue to be a valuable tool for real estate transfers going forward. However, since real estate often includes elements of personal property, like furniture and fixtures, there may be some aspects of the transaction that are not eligible for the deferral. Again, there are many special rules and complex situations that often arise during these transactions, so it is best to seek guidance from a tax professional before planning for a like-kind exchange.
Joseph Emerson, CPA
Joseph Emerson, CPA is a Senior Staff Accountant with GranthamPoole, specializing in the areas of real estate and construction. For more information on the above article or any other TCJA or tax-related topics, please contact your GranthamPoole tax advisor or our Tax Services Team Leader, Melanie Woodrick, CPA at 601.499.2400 or firstname.lastname@example.org.
The above does not represent tax advice. Each situation is fact-dependent, and you should seek the advice of a competent advisor. GranthamPoole PLLC is a provider of tax, accounting, advisory and strategic services, partnering with clients across a broad spectrum of industries and sizes.