Are you selling real estate or other investment or business property like collectibles or cars? Generally, you'll owe capital gains tax on a gain, but you might arrange a Section 1031 exchange of "like-kind property" instead. If certain requirements are met, tax is deferred until you sell the replacement property … if ever.
But the Tax Cuts and Jobs Act (TCJA) throws a curveball into the mix. Beginning in 2018, the tax benefits of Section 1031 exchanges are eliminated, except for swaps of real estate (transitional rules may apply).
Here's what you should know when swapping
No current tax is due on a Section 1031 exchange of like-kind properties, except for any "boot" received. Boot is the term used to describe the cash used or mortgage debt assumed to even out a real estate swap.
For example, say you exchange a building worth $1 million for one worth $950,000. If the other party kicks in $50,000 in cash, that is the boot you would owe capital gains tax on in the year you received it. Assuming it's a long-term gain, the maximum tax would be $10,000 (20 percent of $50,000).
It's good to keep in mind that the definition of "like-kind" real estate properties is expansive. For instance, you can exchange an apartment building for a warehouse or even vacant land. However, to qualify for tax deferral, you must meet two strict deadlines:
- You must identify or actually receive the replacement property within 45 days of transferring ownership of the relinquished property.
- You must receive the title to the replacement property within 180 days or your tax return due date plus extensions for the tax year of the transfer.
Because it's unusual for two investors to each own property the other wants, like-kind exchanges often involve multiple parties. A qualified intermediary may help facilitate an exchange.
Although the TCJA eliminates tax deferral on non-real estate exchanges after 2017, if replacement property was identified before 2018 you can still qualify for a tax-deferred exchange if the title is transferred by this year's deadline. Call us if you have questions.