Take aim at like-kind exchanges

QTA Consultants, Ltd./Renata Bliumaite

The long-standing federal income tax break for like-kind exchanges of real estate is squarely in the crosshairs of the Biden administration.

Strategy: Arrange a like-kind real estate swap before it’s too late. Currently, there is no deadline on the books, but acting sooner rather than later may be advisable. The White House has consistently supported a complete repeal of the like-kind exchange break, but it’s a controversial proposal. Expect the issue to heat up this summer. Of course, this isn’t the only recent tax development relating to like-kind exchanges of property. Back in late 2017, the Tax Cuts and Jobs Act (TCJA) wiped out this tax break for all exchanges other than real estate, beginning in 2018. Saving grace: For many taxpayers, the main focus was on real estate swaps anyway.

Here’s the whole story: Under Section 1031 of the Internal Revenue Code, you can defer federal income tax on a gain when you exchange like-kind real estate properties, except to the extent you receive cash or other “boot” in the transaction. If that occurs, you must pay current tax on the gain up to the amount of boot received. Otherwise, no tax is owed until you sell the new property that replaces the old property you relinquished. To qualify as a tax-favored Section 1031 likekind exchange, both the real estate property that you relinquish and the replacement property that you acquire must be investment or business property. You can’t swap personal-use property under Section 1031. “Like-kind” refers to the property’s nature or character. IRS regulations provide a liberal interpretation of this standard. For example, you can exchange improved real estate for raw land, a shopping mall strip for an apartment building or a marina for a golf course. However, you can’t swap personal-use property like your home. Note that it’s unlikely that someone will own real estate that you want to acquire and also want the property that you want to exchange. Therefore, the vast majority of high-dollar Section 1031 exchanges involve multiple-party swaps. You will usually need to insert a “qualified intermediary” into the mix to make your swap qualify for taxfavored Section 1031 exchange treatment. We will have more on this aspect in a future article. ‘Tis better to give than receive When properties of differing values are exchanged, one party in the transaction must add boot to even out the deal. Boot can take the form of cash or dissimilar property, or a mixture of both. If you receive boot, you owe current tax equal to the lesser of:

• Your realized gain (meaning the difference between the tax basis of the property that you relinquish in the exchange and the fair market value of the replacement property that you receive in the exchange, including any boot).

• The fair market value of the boot that you receive. However, if you’re the one paying boot, that won’t trigger a taxable gain. Thus, it is better from a tax perspective to be on the paying end of boot, rather than the receiving end.

Note: If you relinquish property that has a larger mortgage than the replacement property, the difference is generally treated as boot, which can trigger a taxable gain. Timing is everything.

You must meet two deadlines for a swap to qualify as a tax-favored Section 1031 exchange:

1. You must identify (or actually receive) the replacement property within 45 days of transferring legal ownership of the relinquished property.

2. The title to the replacement property must be transferred to you within the earlier of 180 days or your tax return due date, plus extensions, for the tax year of the transfer. The 180-day period begins to run on the date of the transfer of legal ownership of the relinquished property. If that period straddles two tax years, it might be cut short by the tax return due date. Example: If you relinquish title to property in November or December of this year, the April 15, 2022, due date for your 2021 return will come before 180 days are up.

Tip: If necessary, file for an automatic tax return due date extension. The IRS will extend the due date to October 15, 2022. Then you’ll have the full 180 days to complete the deal.