Generally, if you exchange business or investment property solely for business or investment property of a like-kind, you will not be taxed on any gain you realize in the exchange, but you can't deduct the loss, either. And, all sorts of property qualifies for this special tax treatment, such as motor vehicles, office furniture, and even real estate.

But, in order to take advantage of the like-kind exchange provision of the Internal Revenue Code (IRC), there are several requirements that must be met:

  • There must be an "exchange" of property
  • Both the property exchanged and the property received must be held for productive use in a trade or business or for investment, and
  • The properties exchanged must be of "like kind," and
  • There are identification, reporting, and receipt requirements

Sometimes, it's difficult to determine if a deal qualifies as a like-kind exchange, and sometimes you might even have to report a gain. So, be certain to read the tax laws carefully, or get some help from an experienced real estate or tax law attorney.

Exchange

An "exchange" is a reciprocal, or mutual, transfer of property, as opposed to a transfer of property for money. A sale of property with a reinvestment of the proceeds into a second like-kind property ordinarily does not qualify as an exchange, even if the reinvestment is made immediately, and even if other like-kind exchange requirements are met.

Qualifying Property

Both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. So, if you exchange a home that you bought as an investment for other residential property that you intend to hold as an investment, the exchange will be considered "like kind."

Land, rental houses, and buildings, generally qualify, as do things like machinery and trucks. The rules for like-kind exchanges do not apply to property like:

  • Property used for personal purposes, such as your home and family car
  • Real estate held by dealer, that is, someone whose business is buying and selling real estate

Status as a "dealer" doesn't automatically bar you from having a like-kind exchange. For example, you could be a dealer but also hold land for investment purposes. If you're a dealer, you'll have to prove to the IRS that a particular piece of property was an investment. To prove that, you'll generally have to show that the property was held for the production of income.

Like-Kind Property

Like-kind properties are properties of the same nature or character, even if they differ in grade or quality. For example, an exchange of an apartment building for a retail store is a like-kind exchange, as is a trade of residential property for farmland.

An exchange of personal property for real property is not a like-kind exchange. So, if you trade a bull dozer for an apartment building, it will not qualify as a like-kind exchange.

If, in addition to like-kind property, you receive money (or unlike property, such as a car) and you realize a gain, you have a partially nontaxable exchange. You are taxed on the gain you realize, but only to the extent of the money and the fair market value of the unlike property you receive.

For example, you exchange investment real estate with an adjusted basis of $8,000 for other real estate you'll hold for investment. The fair market value of the real estate you receive is $10,000. You also receive $1,000 in cash. You paid $500 in exchange expenses (closing costs). Although the total gain realized on the transaction is $2,500 ($2,000 difference in land value plus $1,000 cash, minus $500 expenses) only $500 ($1,000 cash received minus the $500 exchange expenses) must be reported by you as income.

Identification, Reporting & Receipt Requirements

You must report an exchange, even if there's no gain or loss, by using a special IRS form. In addition, using the same form, you have to identify the property that you received in the exchange within 45 days after the date you transfer the property given up in the exchange. Identify the property by using the land's legal description or street address.

You have to take receipt of the property you've bargained for by the earlier of:

  • The 180th day after the date on which you transfer the property you've given up, or
  • The due date, including extensions, for your tax return for the tax year when you transferred the property you've given up

Special Rules for Related Persons

When persons who are related exchange property, if either person disposes of the property within 2 years after the exchange, the exchange won't be treated as "like-kind." The gain or loss on the original exchange must be reported as of the date of the second disposition.

Related persons include you and:

  • A family member, like your spouse, parent, or child
  • A corporation in which you have more than 50% ownership
  • A partnership in which you own more than a 50% interest of the capital or profits

Questions for Your Attorney

  • What will happen if I miss the reporting filing dates on a like-kind exchange?
  • What if I bought land for personal use, but now I'm treating it as an investment? Can I use it for a like-kind exchange?
  • Is there a limit to the number of like-kind exchanges I can do per year?