In February of 2008 the IRS released a simple fact sheet providing guidance on deferring capital gains under a like-kind exchange under Section 1031 of the Tax Code (commonly called "1031 Exchanges" or "Starker Exchanges"). The fact sheet is available at http://www.irs.gov/newsroom/article/0,,id=179801,00.html. The IRS issued the fact sheet in an attempt to provide clarification and guidance to taxpayers involved in 1031 Exchanges and was issued just prior to the issuance of IRS Revenue Proc. 2008-16 providing a safe harbor under which the Internal Revenue Service will not challenge whether a vacation home or a second home will qualify for Section 1031 treatment. See  http://www.irs.gov/irb/2008-10_IRB/ar12.html. This blog highlights the provisions of the February 2008 Fact Sheet - next week will discuss the vacation/second home safe harbor rules. 

The topics addressed in the February 2008 fact sheet include: 

• Who qualifies for the Section 1031 exchange? Brief Answer: Owners of investment and business property may qualify for a Section 1031 deferral.
• What are the different structures of a Section 1031 Exchange? Brief Answer: (1) simultaneous swap of one property for another, (2) deferred exchange - the disposition of the relinquished property and acquisition of the replacement property wherein the taxpayer typically uses exchange facilitators under exchange agreements, OR (3) reverse exchange - involves the acquisition of replacement property through an exchange accommodation titleholder, with whom it is parked for no more than 180 days. 
• What property qualifies for a Like-Kind Exchange? Brief Answer: Both the relinquished property (the property sold) and the replacement property (the new property) must meet certain requirements: (1) both properties must be held for use in a trade or business or for investment., (2) both properties must be similar enough to qualify as "like-kind"  - like-kind property is property of the same nature, character or class, (3) 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, and (4) certain types of property are specifically excluded from Section 1031 treatment., including: (a) Inventory or stock in trade, (b) stocks, bonds, or notes, (c) other securities or debt, (d) partnership interests and (e) certificates of trust.
• What are the time limits to complete a Section 1031 Deferred Like-Kind Exchange? Brief Answer:  (1) the taxpayer has 45 days from the date the taxpayer sells the relinquished property to identify potential replacement properties - the identification must be in writing, signed by the taxpayer and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary; and (2) 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. 
• Are there restrictions for deferred and reverse exchanges? Brief Answer:  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. 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 complete.
• How do you compute the basis in the new property? Brief Answer: 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.  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? Brief Answer: The taxpayer must report an exchange to the IRS on  Form 8824, Like-Kind Exchanges (http://www.irs.gov/pub/irs-pdf/f8824.pdf) and  file it with the taxpayer's tax return for the year in which the exchange occurred. 

For additional information from the IRS on 1031 Exchanges, please see IRS Publication 544 - Sales and Other Dispositions of Assets (http://www.irs.gov/pub/irs-pdf/p544.pdf). 

If you are interested in receiving further information about Knight-Barry's 1031 services please contact Kristine Pavich in our Milwaukee office (414-727-4545). 

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