Many people are aware that you can utilize an IRC Sec. 1031 (“like-kind”) exchange to defer gain on a real estate transaction, but an often-overlooked planning opportunity is to utilize a like-kind exchange when selling your construction equipment. By deferring the taxable gain on the transaction, as well as the related tax, you have the ability to increase your cash flow and decrease your borrowing needs.
What is a 1031 Like-Kind Exchange?
Whenever you sell business or investment property and have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property, as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section
1031 is tax-deferred, but it is not tax-free.
What are the advantages of a like-kind exchange?
- Defer tax on the gain from sale of assets
- Increase your cash flow
- Reduce your borrowing needs
- Defer taxes on gains indefinitely if you keep replacing assets through a like-kind exchange
- Have more money to re-invest in equipment
What are some common assets that can be exchanged?
Both relinquished and replacement property must be held for use in a trade or business. Property used primarily for personal use does not qualify. They both must be similar enough to qualify as “like-kind”, which is property of the same nature, character, or class. Quality or grade does not matter.
Real property and personal property can both qualify as exchange properties under Section 1031; but real property can never be like-kind to personal property. In personal property exchanges, the rules pertaining to what qualifies as like-kind are more restrictive than the rules pertaining to real property. For example, when pertaining to real property, trucks are not like-kind to cars.
Finally, certain types of property are specifically excluded from Section 1031 treatment. Section 1031 does not apply to exchanges of:
- Inventory or stock in trade
- Stocks, bonds, or notes
- Other securities or debt
- Partnership interests
- Certificates of trust
What are the time limitations on completing a like-kind exchange?
The like-kind exchange does not have to be swapped at the same time, however, you must meet two time limits or the entire gain will be taxable. These limits cannot be extended for any circumstance or hardship except in the case of presidentially declared disasters.
Once the taxpayer sells the property, the taxpayer has 45 days from the date of sale of relinquished property to identify the new replacement property. The identification must be in writing; signed and delivered to the party involved in the exchange or a qualified intermediary.
The second limit is that the replacement property must be received — and the exchange completed — no later than 180 days after the sale of the exchanged property OR the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above.
Like-kind exchanges can be a great way to defer gain and save money for your construction business. If you have any questions about how to use like-kind exchanges or what may qualify, please give us a call.