Internal Revenue Code § 1031 provides the procedure for a little-used tax shelter known as a like-kind exchange. In essence, §1031 allows the exchange of business or investment property for other business or investment property of like-kind, with tax-deferral benefits. Generally speaking, there are three types of like-kind exchanges: simultaneous; deferred; and reverse. With a simultaneous like-kind exchange, the exchange of the like-kind properties occurs at the same time, whereas a deferred like-kind exchange involves some waiting period before the actual exchange takes place. Lastly, a reverse like-kind exchange involves a situation where an investor acquires a replacement property before selling what the investor plans to exchange.

Sample Fact Scenario

Al and Rita purchased a vacation property on a lake many years ago. The property is approximately an eight-hour drive from Al and Rita's residence. The location became a popular tourist attraction and the value of the property has increased substantially over the years. Now that they are approaching their retirement years, Al and Rita would like to purchase something closer to home. Instead of selling their vacation home, Al and Rita plan to exchange the vacation home for a similar property nearer to their home. It is their hope that the new property will provide some type of income and then, someday, become their retirement home. A like-kind exchange is an option that would afford Al and Rita significant tax deferral benefits.

What Is the Tax Benefit of a Like-Kind Exchange?

If an investor follows the procedure set forth in §1031 in effectuating a like-kind exchange, there is no taxable gain or loss, because the Internal Revenue Service views the transaction as a non-taxable exchange of two similar properties. A like-kind exchange is often used as an estate planning tool.

How Can I Find More Information on Like-Kind Exchanges?

A like-kind exchange is a complicated transaction. Unless an investor strictly adheres to the procedure set forth in §1031, the investor will not be eligible to take advantage of the tax benefits of the exchange. Accordingly, it may be beneficial for an investor to consult a like-kind exchange facilitator, accountant, or an attorney with significant experience in like-kind exchanges, including the planning needed for the exchange and the tax reporting.

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