Farm Estate and Succession Planning
This blog focuses on making complex and difficult topics in estate and business planning understandable and applicable to the reader.
"Like Kind Exchanges" - General Overview
Aug 08, 2011
A very popular “buzz word” in my area of planning involves a “like kind exchange.” This concept, also known as a “1031 exchange” is a tax deferred exchange of assets. It can be accomplished if specific rules are followed and involve the sale and exchange of business assets (with some exceptions).
To qualify as a tax-deferred, like-kind exchange, all of the following conditions must be met:
1) Both the property given and the property received must be held by you for business or investment purposes.
Ø This means that the exchanged property cannot be acquired immediately before or disposed of immediately after the exchange.
Ø There is no definite time that the property must be held to meet this requirement. Generally, the longer you hold the property, the better.
2) The property must not be held for sale to customers, such as inventory or merchandise.
3) There must be an exchange of “like-kind” property.
Ø Equipment exchanged must be for “like” equipment – not exact trade for trade, but they must be the same nature. Equipment for Equipment. Not equipment for vehicles.
Ø Land – any real estate, whether improved or not, is considered “like kind.”
When dealing with like kind exchanges, there is often an issue having to do with “boot.” If there is an unequal transfer, then there is going to have to be cash exchanged. This cash is not like-kind property and will be considered “boot.” The receipt of boot will cause a realized gain on an exchange to be recognized. The gain is realized if the fair market value of the property received exceeds the tax basis of the property given. The amount of gain to recognize in this instance is the lesser of the boot received or the realized gain.
All liabilities transferred to the other party in an exchange are netted against all liabilities assumed by the recipient. The recipient is treated as receiving “boot” only if relieved of greater liabilities than those assumed.
Moreover, depreciation of the machinery that you will separate with the like kind exchange will be an issue to work through with your CPA. There are a few rules to consider, as a part of this analysis, and you should work specifically with your CPA to ensure that it works as you intended.
Something else to consider: If the exchange is not a simultaneous exchange, then the rules for deferred exchanges must be met. This is known as a “reverse Starker” exchange. Contact your professionals for information on this concept.
Once this transfer is completed there are also some restrictions on later sales with a 1031 exchange, especially with related parties. Again, it’s important to work with your professionals on these transactions. They are very useful tools, but as you can see, there are a lot of “hoops” to jump through.
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Required Disclosure Pursuant to IRS Circular 230: Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code; or (2) promoting, marketing or recommending to another party any transaction or matter addressed in this communication.