Still, it’s always advisable to consult with a tax professional or qualified intermediary for guidance throughout the process. The key concept is that the transaction is treated as an exchange rather than a sale, enabling the taxpayer to defer capital gains taxes that would normally be triggered by the sale of an asset. A transaction qualifies as a 1031 exchange if it’s an exchange of eligible like-kind properties. Since the Tax Cuts and Jobs Act (TCJA), only real property qualifies for a 1031 exchange. Sec. 1031 is a decades-old tax provision that has incentivized growth in the real estate industry for many years.
Exchange Rules Overview
Explore property-related timing issues and planning opportunities that can lead to significant tax savings. Learn more about passive activity limitations, like-kind exchanges, involuntary conversions, and Sec. 1237. Dana L. Hart, CPA, Ph.D., is an assistant professor of accounting at the University of Southern Mississippi in Hattiesburg, Miss. To comment on this article or to suggest an idea for another article, contact Dave Strausfeld, a JofA senior editor, at -cima.com. If you don’t have a Gain or Loss account yet, you have to set up the account first before you do your journal entries.
Accounting for 1031 Like-Kind Exchange
This is if, instead of selling it, you exchange it solely for property of a like kind. Therefore, you have use of the tax savings until you sell the replacement property. A 1031 Exchange allows investors to defer capital gains tax that would otherwise be incurred on the sale of investment property.
Is there any other context you can provide?
If, as part of the exchange, you also receive other (not like-kind) property or money, you must recognize a gain to the extent of the other property and money received. IRS Form 8824, “Like-Kind Exchanges,” is used to report journal entry for 1031 exchange each 1031 Exchange. The form helps taxpayers provide details about the properties exchanged and calculate any realized gain or recognized loss. Accurate completion of this form is vital to avoid potential tax penalties.
Internal Revenue Code, is a transaction in which eligible property is exchanged for property of “like-kind” and gain or loss is deferred for federal income tax purposes. Normally, when a taxpayer sells property, gain or loss on the sale is recognized in the tax year in which the sale occurs. But in a like-kind exchange, gain or loss on the sale of relinquished property is deferred until the replacement property is sold. As a practical matter, the Sec. 1031 exchange is usually facilitated by executing an exchange agreement with a QI to ensure that the taxpayer never has access to the sales proceeds from the relinquished property.
- However, real property in the United States is not like-kind to real property outside the United States.
- They are not tax efficient and an investor should consult with his/her tax advisor prior to investing.
- By bringing additional new cash, the LLC fully replaced the value of its old mortgage debt of $200,000.
If this was overwhelming (as it was for me the first time I learned how to walk through this), simply share this with your CPA come tax time if you’ve performed a 1031 exchange. The mistake is to restart depreciation at $120,000 less the cost of land rather than carrying over the old basis and continuing the depreciation schedule. Company A gives an old truck ($1,000,000 cost, $750,000 accumulated depreciation) and $50,000 cash for a boat. However, the tax deferral allows more of your money to remain invested and growing, which can significantly enhance your wealth over time.
Critical to the process is the 45-day Identification Rule and 180-day Completion Rule, with a Qualified Intermediary facilitating the exchange. While a 1031 Exchange typically involves like-kind property, there are exceptions. For instance, a domestic property may not be exchanged for a foreign property. While the rules of 1031 Exchange are quite specific, there are some exceptions and special cases that investors should understand. The IRS is quite clear that any mistakes can lead to the exchange being disallowed and the investor could face an unexpected tax bill.
Here, Sean faces a capital gain of $90,000 (selling $100,000 above his basis minus the $10,000 in closing costs). After considering another $10,000 in closing costs when he purchases his condo, the net value of his replacement property is $260,000. Before amendment by the TCJA, IRC Section 1031 also applied to exchanges of tangible personal property and certain intangible personal property.
Most exchanges of real property involve deferred exchanges that are facilitated through the assistance of a qualified intermediary (QI) and structured to satisfy the QI safe harbor of Treas. As most recently amended under the Tax Cuts and Jobs Act (TCJA), IRC Section 1031(a) states the general rule that no gain or loss is recognized on the exchange of “real property” held for productive use in a trade or business or held for investment. Planning, preparation, and execution of a like-kind exchange is a very rules-based endeavor. Taxpayers and their advisers must be aware of potential pitfalls that can derail any attempt to accomplish a tax-deferred swap of properties. The following issues must be addressed when structuring a Sec. 1031 exchange.
You do not need an equal amount of debt on your replacement property in a 1031 exchange. Regulators designed Section 1031 to promote investment in the economy. This means the IRS wants to tax any value that you do not directly exchange into another investment property. In a 1031 exchange, boot is anything received by the exchanging seller that is not like-kind property. The Final Regulations are important because they reduce uncertainties under existing law by providing a framework for determining whether a particular property (or component thereof) constitutes real property for purposes of IRC Section 1031. In contrast to the Proposed Regulations, the Final Regulations make it clear that local law is one of the factors in determining whether property is real property for IRC Section 1031 purposes.
You’ll likely have to execute a “deferred” exchange, in which you engage a qualified intermediary (QI) for assistance. The same taxpayer that sells the relinquished property must buy the replacement property. In other words, the name on the title of the replacement property must be the same as the name that was on the title of the relinquished property. Careful documentation of the process, including details about the properties exchanged, and precise calculation of gains and losses, is fundamental. IRS Form 8824 serves as the primary tool for reporting these exchanges. Next, the properties’ details and the exchange itself should be entered.