Note that a computer and
office equipment are not like-class property.
A simple example of a like-kind exchange is found in IRS Publication 544: A cab
driver trades in his old cab for a new one. The new cab costs $10,800. He is allowed
$2,000 as trade-in value for his old cab, and pays $8,800 cash. There is no taxable
gain or deductible loss, regardless of the basis of his old cab. The basis of
his new cab simply becomes the basis of the traded in cab. Let's say the old cab
was fully depreciated for tax purposes so that the basis is $0. The cab driver
has a realized gain of $2,000 (trade-in amount allowed - basis), but the entire
gain is postponed for tax purposes due to the like-kind exchange rules. The basis
of the new cab is $8,800, or the cash paid. If the cab driver later sells the
new cab for $10,800, then his taxable gain at that time would be $2,000 (Selling
price minus the basis or $10,800-$8,800).
Partially
Nontaxable Exchanges
If you
receive cash or unlike property and you have a realized gain in a like-kind exchange,
you have a partially taxable exchange. The realized gain is taxed, but only
to the extent of the money and fair market value of unlike property you receive.
Of course, if you have a loss in a nontaxable exchange it is never deductible,
even if you receive unlike property or cash.
A
simple example involving the exchange of real estate will help explain partially
taxable exchanges. Note that if the other party to a nontaxable exchange assumes
any of your liabilities, or if you transfer property subject to a liability, you
will be treated as if you received cash in the amount of the liability.
| Fair market
value of real estate Received | $
10,000 |
| Cash
received | 1,000 |
| Mortgage assumed
on property given up | 3,000 |
| Total received |
$14,000 |
| Minus: *Exchange
expenses | (500) |
| Amount Realized |
$13,500 |
| Minus: Adjusted
basis of property given up | (8,000) |
| Realized gain |
$ 5,500 |
The realized gain is only recognized
up to the amount of the cash received and the mortgage assumed ($1,000 cash received
- $500 in exchange expenses + $3,000 for the mortgage assumed) or $3,500.
*Exchange
expenses may include closing costs such as brokerage commissions, attorney fees,
and deed preparation fees.
If you
give up like and unlike property, except cash, you must recognize a gain or loss
on the unlike property given up. The gain or loss equals the difference between
the fair market value of the unlike property and its adjusted basis.
Deferred
Exchanges
A deferred
exchange occurs when you transfer property held for investment or used in your
business and, at a later time, you receive like-kind property or replacement property.
If, before you receive
the replacement property, you receive money or unlike property in full payment
for the property transferred, the transaction is treated as a sale. You must recognize
a gain or loss on the sale, even if you later receive the replacement property.
To qualify as a deferred exchange, the replacement property must be identified
within 45 days after the date you transfer the property given up. Also, the replacement
property must be received by the earlier of:
Summary
Nontaxable exchanges can be quite
complex and generally require the skills of an attorney that specialize in such
transactions. Also, there are qualified intermediaries, such as some financial
institutions, that assist with these transactions.
If
you have questions pertaining to like-kind exchanges or other tax related issues,
please call The Henssler Financial Group at 770-428-4025.
A
like-kind exchange, or 1031, exchange is used to defer the capital gain on the
exchange of business or investment property for the same kind of property.