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The Effects of TCJA on Like-Kind Exchanges

The sale or exchange of property is generally a taxable event. However, under IRC Section 1031, no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged for property of a “like kind” which is to be held for productive use in a trade or business or for investment, when certain parameters are met. Section 1031 of the Internal Revenue Code has historically allowed taxpayers to defer gains on real or personal property exchanged for property of a “like kind” until the future sale of the replacement property.

The Tax Cuts and Jobs Act of 2017 (TCJA) now limits the non-recognition treatment to only like-kind exchanges of real property (not held primarily for sale), eliminating the taxpayer’s ability to defer gains on all types of personal property, including intangible property. Exchanges of machinery, equipment, vehicles, intellectual property, artwork, and other personal and intangible business assets no longer qualify. The provision generally applies to exchanges completed after December 31, 2017. However, if one side of the exchange transaction (either the disposition or the receipt of the exchange property) occurred before January 1, 2018, then the pre-TCJA rules will apply.

This provision could have an unexpected negative impact on certain exchanges of real property.  If a taxpayer gives or receives property that is not like-kind property as part of a larger transaction, gain recognition may occur. Property that is not like-kind property is called boot. Under the new provision, if an exchange of real property also includes ancillary personal property, the personal property would be considered boot and could create a taxable gain for the taxpayer.  One potential solution to this issue is for a taxpayer to look to the significant bonus depreciation options available to mitigate that gain.

An example of this issue is as follows. A transaction involving multi-unit apartment buildings may include personal property items such as appliances, furniture, and equipment. In this case, a reasonable allocation of the transaction proceeds must be made to the personal property, and income must be reported from the disposition of that property. Receiving boot triggers gain recognition if there is a realized gain (when the fair market value of the property received exceeds the tax basis of the property given up). The recognized gain is the lesser of the boot received or the realized gain.

Taxpayers need to be aware of the effects of this new provision before entering into future like-kind exchanges under Section 1031. As always, please contact a member of Withum’s Real Estate Services Group if you have any questions.

Author: Laura Riso, CPA, Real Estate Services Group Team Member  |  lriso@withum.com

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