Facts: requirements in acquiring an investment property during similar exchange, key considerations of acquiring an investment or business through like-kind exchange, basis of property acquired through like-kind means, non-recognition provision similar exchange and the US tax code section 1031 considered similar exchange.
Issue: is it possible to acquire an investment property or business through a like-kind exchange
without facing any form of taxation from the tax authority on matters related to the property itself?
Discussion: the topic of discussion arises on the issue related to acquiring another property through a like-kind exchange transaction. A like-kind exchange involves acquiring a business by exchanging it with another business or exchanging an investment property for another investment property, which are of same kind. Gain or loss in such an exchange is non-recognized by the Code section 1031. Properties regarded to be of like- kind if they have the same character or are of the same nature (United States Tax Court.). Investment properties regarded to be of the same kind even if they are improved or not, only the nature of the property taken into consideration and not the quality of the property itself, therefore, the major requirement to facilitate a like- kind exchange is that the properties should be of the same nature.
According tax laws, should a person benefit by getting a gain from an exchange, he/ she should pay the tax borne on that gain, however IRC 1031 gives an omission to that rule and keeps you from giving tax on gain received under the condition that you reinvest that gain in another business of the same nature. The gains may be subject to taxation but only to the limits of operations not similar This therefore brings in the concept of deferring tax, which however should not be confused for being tax free (Horan 70).
IRC section 1031 requires that the property to be exchanged for, be identified 45 days prior to transferring the original property and must be attained during not more of 180 days from the original property has been transferred to the new owner. Payment of tax deferred only if an independent party handles the proceeds of the sale and keeps them away from the taxpayer and better yet, tax shall only be paid on the replacement property once it is sold, without reinvesting it for a qualifying property ((United States Tax Court.).
Section 1001(c) requires that all income be recognized and taxed unless otherwise stated. Like- kind exchange is one of the few scenarios considered, where taxation on the gains is exempted referred to as “a non- recognition provision”.
A Limited Liability Company (LLC), is regarded as a separate entity independent from the persons who started it. This is mainly for tax purpose. The owners, regarded as shareholders whose stake on the entity is determined by the amount of share capital endowed by a single shareholder. The LLC files its own tax return and viewed as a legal person who can transact, buy or sell property, sue or be sued in a court of law.
Shareholders have the right to transfer their ownership of the entity by selling their shares to another person. The person with the majority shares has greater control in terms of decision making on matters pertaining to the entity. The LLC files its own separate tax return to the register of companies. The tax return should be independent from tax paid on the pro-rata income enjoyed by the shareholders
For taxation purposes, there are several legal requirements that include; apart from a sole proprietor, an investor has to apply for an Employee identification number and a National Standard Employer Identifier for your electronic health transaction.
Conclusion: yes! It is possible to exchange one property for another without paying any tax provided the proceeds gained from selling the old property are used to acquire another property that is of similar nature and character. This is evidenced according to IRC section 1031. such a tax deferred instead of having to pay on the gain received on the transfer of the property. The simplest outline of IRC 1031 exchange is where property is simply swapped with another. Great emphasis is placed on qualification for section 1031 exchange, the properties should be business or investment proposes and not for personal residence or vacation homes.
To the client;
Tom Jones.
A research carried out on the concept of like- kind exchange that the client would like to use to acquire Quake, an LLC in exchange of his property (land A). The results of the research found that, the client would be operating under section 1031 revenue code that waives the issue of liability on the taxpayer when exchanging property, on the ultimatum that the property will be of similar nature or character and should be in 45 days relinquishing the previous property. The work of identifying the like- kind property should be done by the client, signed by him/her and delivered to the person in-charge of the exchange.
The client should bear in mind that taking affirmative control of the cash or proceeds before the transfer is complete may render the transaction null and void from the like- kind exchange provision, (United States Tax court). The client requires having a facilitator to avoid having an untimely receipt of cash the facilitator requires being an independent party that has no interest in the transaction and therefore, your real estate agent, attorney; accountants are not qualified to act as your facilitator (Horan 75).
There are several requirements that have to be met to qualify as similar exchange (IRC section 1031):
1. The property being exchanged must be solely used for trade or investment and not for personal use
2. The property being exchanged (new property) must be of same nature or character as the old asset.
3. The gains received should buy the new property in a period not less more than 180 days prior to selling the old property.
4. Investor can’t be his own facilitator as premature handling of the proceeds may result to disqualifying the transaction from being similar exchange.
A like- kind exchange is therefore, quite good if the client does not want to face tax payment requirements and where the client still wants to continue with the current business or investment.
Work sited
Horan, V. E. How to Do a Like Kind Exchange of Real Estate: Using a Qualified Intermediary: Haymarket. Trafford Publishing, Business & Economics 2005.
United states Tax court. Like-Kind Exchanges – Real Estate Tax Tips. 2011. Retrieved from: http://www.irs.gov/businesses/small/industries/article/0,,id=98491,00.html
Ogden, G. Andrew. The 1031 Exchange Handbook: boulder.1031 Education Center 2009.
Smith, E. James. Raabe, A. William. Maloney & M. David. South-western Federal Taxation 2010: Taxation of Business Entities with tax cut tax preparation software: Cengage Learning, Business & Economics. 2009
