Source: Internal Revenue Service
United States Department of the Treasury
Like-Kind Exchanges Under IRC Code Section1031
FS-2008-18, February 2008
WASHINGTON â€” Whenever you sell business or investment property and you 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.
The exchange can include like-kind property exclusively or it can include like-kind property
along with cash, liabilities and property that are not like-kind. If you receive cash, relief from
debt, or property that is not like-kind, however, you may trigger some taxable gain in the year
of the exchange. There can be both deferred and recognized gain in the same transaction
when a taxpayer exchanges for like-kind property of lesser value.
This fact sheet, the 21st in the Tax Gap series, provides additional guidance to taxpayers
regarding the rules and regulations governing deferred like-kind exchanges.
Who qualifies for the Section 1031 exchange?
Owners of investment and business property may qualify for a Section 1031 deferral.
Individuals, C corporations, S corporations, partnerships (general or limited), limited liability
companies, trusts and any other taxpaying entity may set up an exchange of business or
investment properties for business or investment properties under Section 1031.
What are the different structures of a Section 1031 Exchange?
To accomplish a Section 1031 exchange, there must be an exchange of properties. The
simplest type of Section 1031 exchange is a simultaneous swap of one property for another.
Deferred exchanges are more complex but allow flexibility. They allow you to dispose of
property and subsequently acquire one or more other like-kind replacement properties.
To qualify as a Section 1031 exchange, a deferred exchange must be distinguished from the
case of a taxpayer simply selling one property and using the proceeds to purchase another
property (which is a taxable transaction). Rather, in a deferred exchange, the disposition of
the relinquished property and acquisition of the replacement property must be mutually
dependent parts of an integrated transaction constituting an exchange of property.
Taxpayers engaging in deferred exchanges generally use exchange facilitators under
exchange agreements pursuant to rules provided in the Income Tax Regulations.
A reverse exchange is somewhat more complex than a deferred exchange. It involves the
acquisition of replacement property through an exchange accommodation titleholder, with
whom it is parked for no more than 180 days. During this parking period the taxpayer
disposes of its relinquished property to close the exchange.
What property qualifies for a Like-Kind Exchange?
Both the relinquished property you sell and the replacement property you buy must meet
Both properties must be held for use in a trade or business or for investment. Property used
primarily for personal use, like a primary residence or a second home or vacation home, does
not qualify for like-kind exchange treatment.
Both properties must be similar enough to qualify as "like-kind." Like-kind property is property
of the same nature, character or class. Quality or grade does not matter. Most real estate will
be like-kind to other real estate. For example, real property that is improved with a residential
rental house is like-kind to vacant land. One exception for real estate is that property within
the United States is not like-kind to property outside of the United States. Also,
improvements that are conveyed without land are not of like kind to land.
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. As an example, cars are not like-kind to trucks.
Finally, certain types of property are specifically excluded from Section 1031 treatment.
Section 1031 does not apply to exchanges of:
What are the time limits to complete a Section 1031 Deferred Like-Kind Exchange?
- Inventory or stock in trade
- Stocks, bonds, or notes
- Other securities or debt
- Partnership interests
- Certificates of trust
While a like-kind exchange does not have to be a simultaneous swap of properties, 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.
The first limit is that you have 45 days from the date you sell the relinquished property to
identify potential replacement properties. The identification must be in writing, signed by you
and delivered to a person involved in the exchange like the seller of the replacement property
or the qualified intermediary. However, notice to your attorney, real estate agent, accountant
or similar persons acting as your agent is not sufficient.
Replacement properties must be clearly described in the written identification. In the case of
real estate, this means a legal description, street address or distinguishable name. Follow the
IRS guidelines for the maximum number and value of properties that can be identified.
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.
Are there restrictions for deferred and reverse exchanges?
It is important to know that taking control of cash or other proceeds before the exchange is
complete may disqualify the entire transaction from like-kind exchange treatment and make
ALL gain immediately taxable.
If cash or other proceeds that are not like-kind property are received at the conclusion of the
exchange, the transaction will still qualify as a like-kind exchange. Gain may be taxable, but
only to the extent of the proceeds that are not like-kind property.
One way to avoid premature receipt of cash or other proceeds is to use a qualified
intermediary or other exchange facilitator to hold those proceeds until the exchange is
You can not act as your own facilitator. In addition, your agent (including your real estate
agent or broker, investment banker or broker, accountant, attorney, employee or anyone who
has worked for you in those capacities within the previous two years) can not act as your
Be careful in your selection of a qualified intermediary as there have been recent incidents of
intermediaries declaring bankruptcy or otherwise being unable to meet their contractual
obligations to the taxpayer. These situations have resulted in taxpayers not meeting the strict
timelines set for a deferred or reverse exchange, thereby disqualifying the transaction from
Section 1031 deferral of gain. The gain may be taxable in the current year while any losses
the taxpayer suffered would be considered under separate code sections.
How do you compute the basis in the new property?
It is critical that you and your tax representative adjust and track basis correctly to comply
with Section 1031 regulations.
Gain is deferred, but not forgiven, in a like-kind exchange. You must calculate and keep track
of your basis in the new property you acquired in the exchange.
The basis of property acquired in a Section 1031 exchange is the basis of the property given
up with some adjustments. This transfer of basis from the relinquished to the replacement
property preserves the deferred gain for later recognition. A collateral affect is that the
resulting depreciable basis is generally lower than what would otherwise be available if the
replacement property were acquired in a taxable transaction.
When the replacement property is ultimately sold (not as part of another exchange), the
original deferred gain, plus any additional gain realized since the purchase of the replacement
property, is subject to tax.
How do you report Section 1031 Like-Kind Exchanges to the IRS?
You must report an exchange to the IRS on Form 8824, Like-Kind Exchanges and file it with
your tax return for the year in which the exchange occurred.
Form 8824 asks for:
If you do not specifically follow the rules for like-kind exchanges, you may be held liable for
taxes, penalties, and interest on your transactions.
- Descriptions of the properties exchanged
- Dates that properties were identified and transferred
- Any relationship between the parties to the exchange
- Value of the like-kind and other property received
- Gain or loss on sale of other (non-like-kind) property given up
- Cash received or paid; liabilities relieved or assumed
- Adjusted basis of like-kind property given up; realized gain
Beware of schemes
Taxpayers should be wary of individuals promoting improper use of like-kind exchanges.
Typically they are not tax professionals. Sales pitches may encourage taxpayers to
exchange non-qualifying vacation or second homes. Many promoters of like-kind exchanges
refer to them as â€œtax-freeâ€� exchanges not â€œtax-deferredâ€� exchanges. Taxpayers may also be
advised to claim an exchange despite the fact that they have taken possession of cash
proceeds from the sale.
Consult a tax professional or refer to IRS publications listed below for additional assistance
with IRC Section 1031 Like-Kind Exchanges.
- Publication 544, Sales and Other Dispositions of Assets
- Form 8824, Like-Kind Exchanges (PDF)
- Form 4797, Sales of Business Property