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Like-Kind Exchanges Under IRC Code Section 1031 For Ranch and Farm Land

Posted in: Texas Ranches, New Mexico Ranches, Colorado Farm and Ranch, Recreational Ranches, Cattle Ranches
By Charlie Middleton via sources listed


Like-kind exchanges have been a vital part of the Internal Revenue Code under Section 1031 for many years. A 1031 exchange allows an investor to defer capital gains when exchanging one property for another “like-kind” property.

Contrary to popular belief, Section 1031 is not a loophole or a tax savings vehicle. The capital gains tax is not avoided, only deferred, thus the more common name "tax deferred exchange".

Over time, 1031 exchanges have become an important fixture in the economy and the real estate industry. We have seen in our business that over 50% of the transactions we handle involve a 1031 either on the side of the seller, the buyer or both.

The essential logic is that the investor, in exchanging one property for another like-kind property, has not realized the gain inherent in the relinquished property. The investor has merely changed the form of his investment.

Since the basis of the relinquished property becomes the basis of the replacement property, the built-in gain is still there; it will be taxed later when the investor actually realizes the gain by selling the property for cash.

The rules are fairly simple generally, however, there are some time constraints that must be met to qualify. The 45/180 day rule as it has become known sets the limits involved.

The IRS website reads: you have 45 days from the date you sell the relinquished property to identify potential replacement properties. The identification must be in writing, signed by you and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary. Notice to your attorney, real estate agent, accountant or similar persons acting as your agent is not sufficient.

The second limit is that the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above.

It is important to know that taking control of cash or other proceeds before the exchange is complete may disqualify the entire transaction from like-kind exchange treatment and make ALL gain immediately taxable.

If cash or other proceeds that are not like-kind property are received at the conclusion of the exchange, the transaction will still qualify as a like-kind exchange.  Gain may be taxable, but only to the extent of the proceeds that are not like-kind property.

One way to avoid premature receipt of cash or other proceeds is to use a qualified intermediary or other exchange facilitator to hold those proceeds until the exchange is complete.

You can not act as your own facilitator. In addition, your agent (including your real estate agent or broker, investment banker or broker, accountant, attorney, employee or anyone who has worked for you in those capacities within the previous two years) can not act as your facilitator.

More Information

To qualify for Section 1031 of the Internal Revenue Code, the properties exchanged must be held for productive use in a trade or business or for investment. Stocks, bonds, and other properties are listed as expressly excluded by Section 1031 of the Internal Revenue Code, though securitized properties are not excluded. The properties exchanged must be of "like kind", i.e., of the same nature or character, even if they differ in grade or quality. (Wikipedia)

This article should not be taken as legal advice. Always consult an attorney or your CPA prior to entering into a 1031 transaction.

Like-kind exchanges have been a vital part of the Internal Revenue Code under Section 1031 since 1921. A 1031 exchange allows an investor to defer the recognition of capital gains when exchanging one appreciated investment property (the “relinquished property”) for another “like-kind” investment property (the “replacement property”).

Most commercial 1031 exchanges today are orchestrated transactions in which an investor uses a qualified intermediary (QI) to facilitate the sale of the relinquished property to one party and the purchase of the replacement property from another party. The capital gain inherent in the relinquished party is not taxed upon its transfer.

However, since the basis of the relinquished property becomes the basis of the replacement property, the capital gains tax is not eliminated, it is merely deferred until the property is sold, or exchanged for non-like-kind property.

Contrary to popular myth, Section 1031 is not a loophole or a tax savings vehicle. As mentioned above, the capital gains tax is not avoided — it is merely deferred. This outcome is based on sound tax policy.

The essential logic is that the investor, in exchanging one appreciated property for another like-kind property, has not realized the gain inherent in the relinquished property. The investor has merely changed the form of his investment.

Since the basis of the relinquished property becomes the basis of the replacement property, the built-in gain is still there; it will be taxed later when the investor actually realizes the gain by selling the property for cash.

Section 1031 accurately reflects the economic reality of investment continuity in which no profit is realized, thus there is no premise for taxation.

Over time, 1031 exchanges have become an important fixture in the economy and the real estate industry. This is particularly true in the commercial market, where approximately 25 percent of all transactions involve an exchange on either the sale or purchase.

What’s more, 1031 exchanges allow investors to freely adjust their investments among like-kind properties, allowing for a more efficient allocation of capital.

Exchanges allow investors and business owners to change geographic locations, consolidate, diversify and redeploy into different types of investment assets. This commercial activity creates jobs, financial opportunities and provides a valuable stimulus to many economic sectors.

Section 1031 Under Siege

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