When Apples Equal Oranges Like-Kind Exchanges

A taxpayer normally recognizes gain or loss realized on the sale or exchange of property. However, pursuant to Section 1031 of the tax code, there is no recognition of gain or loss on the exchange of property for like-kind property.

Like-kind property is property that is not a primary residence and that which is classified as an investment or used for business purposes. Like-kind property must be of the same nature or character rather than the same grade or quality. Exchanges of personal property must be nearly identical.

In this type of transaction, however, the taxpayer must hold both the property transferred and the property received, either for productive use in a trade or business, or for investment to qualify for the tax-free treatment.

Generally, the basis of property acquired in the exchange is - with certain modifications - the same as the basis of the property transferred. Since the old basis is substituted as the basis of the acquired property, there is in effect a deferral of the original gain until some time in the future when the acquired property is disposed of in a taxable transaction. If the like-kind exchange involves depreciable property, the acquired property will be depreciated based upon the substituted basis, which could result in lower depreciation deductions than the ones available if the property was purchased outright.

Definition of Like-Kind Property

There are two ways that depreciable tangible personal property can satisfy the like-kind requirement. An exchange for property of a like-kind, e.g. a truck for a truck, or an exchange within the same general Asset Class or Product Class (as defined by the tax code regulations), are permitted. Other personal property must be exchanged for like-kind property in order to qualify for the nonrecognition provision. A like-kind exchange could be consummated with a condominium apartment, a single- or multi-dwelling family house, or even a co-op, but there might be some restrictions in doing so under state law and co-op transactions are subject to board approval.

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