Tax Law Limits Like-Kind Exchanges

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A like-kind exchange (also known as a 1031 exchange after its tax code section) allows a taxpayer to dispose of an asset and acquire a replacement without generating tax liability from the sale of the first asset. For example, if you own an asset worth $100,000 for which you paid $20,000, you will have an $80,000 taxable gain if you sell it. The 1031 exchange rules allow you to exchange that asset for a similar asset worth at least $100,000 without recognizing any income. The untaxed gain becomes part of the new asset and is eventually taxed when the new asset is sold.

 

Some assets, such as inventory or investments in corporate stock and partnership interests, have always been ineligible for 1031 exchanges. Past tax reform proposals have recommended limits to 1031 exchanges, such as by completely eliminating them or by capping their deferred gain at $1 million per year. However, the law was never substantially altered until the Tax Cuts and Jobs Act (TCJA) was enacted in December 2017.

 

TCJA eliminates like-kind exchanges after 2017 for all assets except real estate. Personal property exchanges are no longer eligible, but real property exchanges survive intact. In fact, most exchanges do involve real property, but it has also been common to see exchanges of asset like airplanes, fleet vehicles, and highway construction equipment. 1031 exchanges are routinely used when an older vehicle is traded in for a new model. These personal property exchanges will now be taxable.

 

While the real estate industry escaped unscathed, other businesses that had been utilizing tax-free trades will now find a tax bill on these exchanges. For example, professional sports team owners generally utilized 1031 exchanges when they traded the contract of one highly paid athlete for another. The specter of paying substantial capital gains tax to move players may put a damper on the trading market.

 

Please contact your LMC professional if you have questions about the new like-kind exchange rules or any other provisions of TCJA.

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