A Like-Kind Exchange (LKE) worksheet is what a taxpayer reviews to understand the tax consequences of selling real and personal property and whether there is sufficient capital gain to initiate a 1031 exchange. The process starts with the original purchase price and ends with the recognized gain. The tax due is dependent upon the federal filing status of the taxpayer, the adjusted gross income and whether the asset being sold was held for less than a year or greater than one year and a day. Capital gain on assets held for less than one year are taxed as ordinary income while assets held for more than a year and a day before closing are taxed at long term capital gain rates.
The 1031 Exchange Blog
A 1031 exchange is used to defer federal and state capital gain and recaptured depreciation taxes when selling real and personal property given like-kind property is replaced within 180 calendar days of the initial closing. The sale is grouped into asset or product classes including real property, tangible and intangible personal property. Good will is not eligible for a 1031 exchange. Should the business owner be the lessor of a thirty year or more lease, the lease is considered real property and can be replaced with a real property fee interest.
Upon the sale of real or personal property held in a business or for investment, the seller is subject to a hefty capital gains and recaptured depreciation tax which would be due upon the sale on the realized gain over the original purchase price. Though capital gains tax is excludable up to $250,000 or $500,000 for property owners selling their primary residence once every two years per Section 121, for an investor selling real or personal property, it is possible to defer the tax with a 1031 like kind exchange. A 1031 like kind exchange is a fairly complex transaction that can be a great benefit to the property owner if done correctly.
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The capital gain tax implications on the sale of real or personal property held in the productive use of a business or held for investment can be quite substantial, often bringing into question whether or not the sale is still beneficial to the Taxpayer. A Section 1031 like kind exchange (dubbed after Section 1031 of the Internal Revenue Code) is intended to delay the tax on a capital gain to a time in the future. Here is what a person contemplating a 1031 exchange should know.
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The term “like-kind exchange” describes the federal and state capital gains tax deferral strategy requirement of an Internal Revenue Code (IRC) Section 1031 tax deferred exchange that properties exchanged must be like-kind to one another. A 1031 exchange effectively defers the gain triggered by the sale that can represent upwards of 40 percent of the property’s sales price. The like-kind exchange represents an indefinite, interest free loan that is due when the replacement property is sold, unless the basis is stepped up to the taxpayer’s heirs or another like-kind exchange is initiated.
A 1031 exchange represents a solid strategy for deferring the capital gains and recaptured depreciation taxes when selling and replacing like-kind, real and personal property held for productive use in a trade, business or for investment. These tax deferrals, along with asset liquidity, are the core benefits of the 1031 exchange.
Internal Revenue Service Form 8824, “Like-Kind Exchanges,” is the two-page form to report gain or loss on a 1031 exchange. The form is filed along with the taxpayer’s federal income tax return to support their intent to initiate and secure the 1031 tax deferral for gain or loss from property held for and replaced by property held for productive use in a trade, business or for investment. When exchanging real estate, the title or closing attorney submits a 1099 to the Internal Revenue Service and provides a copy to the taxpayer. The 1099 reflects the gross sales amount received for the real property. Form 8824 represents the taxpayer’s reporting on how those funds were utilized.
Often the question is asked whether in a 1031 like-kind exchange must land be exchanged for land. The answer is found in the like-kind requirement under Internal Revenue Code (IRC) Section 1031. To qualify for consideration in a 1031 exchange, the relinquished or old property and the replacement property must be like-kind. Property is either real or personal property held for productive use in a trade, business or for investment.
One of the fundamental rules of a 1031 Exchange is that the properties exchanged must be of “like-kind”. Given the importance of this rule, understanding what qualifies as “like-kind” is imperative to using a 1031 Exchange to your advantage. If the transaction qualifies for Section 1031 Exchange treatment though, the capital gains tax obligation can be deferred, potentially saving a substantial amount of money that can then be re-invested.
1031 investment property is real or personal property held for the proper intent as defined by Internal Revenue Code § 1.1031. 1031 exchanges allow the owner to indefinitely defer the federal and state capital gains and recaptured depreciation taxes triggered when the property is sold and replaced with like-kind property. Taxes are due when the replacement property is sold or deferred in another 1031 exchange.