A like-kind exchange is a tax reduction strategy when selling business/investment property. The asset class best suited for a tax-free exchange is real estate because it is an appreciating asset. Asset appreciation, along with accumulated depreciation deductions taken on improvements to the real estate, constitute taxable income when the real estate is sold outright.
An attractive element to a real estate like-kind exchange is that the replacement realty does not have to be of the same type as the relinquished realty, but it must used or intended to be used as business or investment realty. For example, a farmer could sell his farm and purchase a shopping center via a 1031 exchange and achieve significant federal income tax deferral. The degree of income tax deferral will be a function of several factors, including the purchase price of the replacement property and the amount of indebtedness on each property, among others.
The federal tax law regarding the standard delayed like-kind exchange is mechanical. A special escrow agent called a qualified intermediary holds the proceeds from the sale of the relinquished property. The replacement realty must be identified to the QI within 45 days of the sale and the purchase of that specific identified realty must occur within 180 days of the original sale for the exchange to complete and tax deferral achieved. In Pennsylvania, you cannot defer state income tax due on sale of realty using a 1031 exchange.
There are variations to the standard like-kind exchange that are more complicated in nature (e.g. a reverse exchange) and require advanced planning.
We understand the advantages and issues associated with 1031 exchanges and can assist sellers of real estate design and implement a financial plan using a 1031 exchange, including the identification of the replacement real estate.
