The 1031 like kind exchange target persona is an individual or corporation who owns real or personal property held for productive use in a trade, business or investment and subject to US federal and state capital gain taxes. The target market will defer $3.7 billion in federal capital gain taxes in 2013 according to the Joint Committee on Taxation. Do you own land, improved property or tangible and intangible personal property, including aircraft, construction equipment, livestock, gold and silver bullion, collectibles, vintage cars or artwork? When selling, is your intention to replace with another like kind property? If selling real property, like kind means any type of real property, including a lessee’s interest in a thirty year lease. If selling personal property, the replacement personal property must be like kind or like class, as in bull for bull, gelding for a male horse or silver bullion for silver bullion.
When selling a business, consideration of the tax consequences, including a 1031 exchange is often not at the top of the list. Following a meeting with your CFO or CPA, the federal, state and recaptured depreciation tax obligation is determined and now included in the dizzying array of outcomes as is the decision of whether or not to replace the assets. By replacing all or some of the assets, the federal, state and recaptured depreciation taxes can be deferred in a 1031 exchange. Rather than paying the tax, those dollars can be used towards as an interest free loan towards acquiring replacement property. The tax obligation does not go away, but is postponed; delayed until time the newly acquired property is sold. Another 1031 exchange is possible, or should the assets be inherited, the basis is stepped up to the heirs.
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.
For those not familiar with 1031 exchanges, the definition and application of like-kind requires an explanation to fully appreciate the breadth and depth. 1031 like-kind exchanges were first legislated as part of the National Revenue Act of 1921. 1031 exchanges were created under the premise that when a taxpayer reinvests the sale proceeds into another like-kind property, the economic gain has not been realized (creating the funds to pay the capital gains tax). The taxpayer’s economic position is the same, only the property has changed, as in land for an investment rental property. Consequently, to pay the tax when the replacement property of equal or greater value is acquired is unfair. Rather, when the replacement property is sold, the deferred gain from the original property plus any additional gain realized since the purchase of the replacement property is subject to tax. If another 1031 exchange is initiated, the tax is deferred.
In the wake of the economic downturn which commenced in 2008, gold and other precious metals have performed better than many other categories of investment assets. Taxpayers interested in avoiding capital gain taxes when they dispose of their appreciated precious metal assets are now looking to Section 1031 exchanges to defer their gains. For individual precious metal investors, a 1031 exchange may be particularly compelling because a special capital gain tax rate of 28 percent (as opposed to the general rate of 15%) applies to “collectibles,” which are defined to include any precious metals and most coins. A threshold issue for taxpayers considering exchanges of precious metals or coins is what types of assets qualify as like-kind.
1031 eligibility is impacted by whether the Taxpayer is considered an investor or collector. Section 1.1031 of the Internal Revenue Code defines an exchange as "No gain will be recognized on property held for productive use in business or investment when exchanged for like kind property held for productive use in business or investment." The real and personal property held by the Taxpayer must be for use in a business or for investment versus predominantly for personal pleasure, use or enjoyment.
With the price of gold experiencing growth, a question often asked is whether gains on the sale of numismatic type coins are 1031 eligible. Can numismatic type coins be replaced with bullion type coins?
Over the years while speaking at seminars and in phone consults, three common 1031 exchange myths appear. Prior to getting to the three myths, let's cover "what is a 1031 exchange?"
A reverse 1031 exchange represents an excellent strategy to snap up bargains and defer capital gains tax. With the abundance of distressed properties, those who are able, often will diversify their holdings and purchase assets that will inevitably appreciate.