Section 1031 exchanges are better known as “Like-Kind Exchanges.” Under the rules prior to the Tax Cuts and Jobs Act (TCJA), capital gains tax could be deferred…

Section 1031 exchanges are better known as “Like-Kind Exchanges.” Under the rules prior to the Tax Cuts and Jobs Act (TCJA), capital gains tax could be deferred when any type of property (real, personal, or intangible) was sold and replaced with property that is the same nature or character, even if it differs in grade or quality. In these situations, as long as the exchange was for property of equal or greater value, the tax on any gains could be delayed. Under the new tax law, the rules apply only to real property.

Real Estate Exchanges

Real estate exchanges are still subject to the same rules as under previous law. There is a 45-day period to identify a replacement property and 180-day period to close on the exchange property. Also, a Qualified Intermediary (or “accommodator”) must hold the sales proceeds in escrow until the replacement property is purchased. All domestic real estate, improved or unimproved, remains like-kind to all other domestic real estate. Foreign real estate is not like-kind to real estate in the U.S.

What is the criteria?

In order for a replacement property to be considered valid, one of three criteria must be met.

  • The Three Property Rule means up to three different properties must be identified as potential purchases within the 45-day identification period. This step does not consider total fair market value of the properties.
  • The 200% Rule allows an unlimited number of replacement properties to be named, however the total fair market value of all properties cannot exceed 200% of the value of the relinquished property.
  • The 95% Rule also allows the investor to identify as many exchange properties as they want, as long as at least 95% of the value of all identified replacement properties is received prior to the end of the exchange period.

Non-Real Property

Although not quite the same as a 1031 exchange, the TCJA does help alleviate some of the tax burden of a gain on the sale of non-real property by allowing the full cost of new, replacement property to be expensed in the year placed in service. This deduction can potentially offset some of the capital gain and the associated tax. The full expensing rule is temporary though. It is currently set to expire after 2022, and will be reduced to 80% for assets placed in service in 2023, 60% for 2024, 40% for 2025 and 20% for 2026. This deduction applies to both new and used assets acquired by the taxpayer.

Have Questions?

Section 1031 exchanges are a great way to defer gain recognition on property, and should always be considered if you are buying and selling real estate. If you have questions regarding like-kind exchanges or need help with tax planning, contact our tax professionals at The Innovative CPA Group at 203-489-0612.  Or contact us online.