6.1 Trades of Like-Kind Property

You may not have to pay tax on gain realized on the “like-kind” exchange of business or investment property. By making a qualifying exchange, you can defer the gain. On the other hand, a loss is not deductible unless you give up “unlike” property (not like-kind); see below. For tax-free gain treatment, you must trade property held for business use or investment for like-kind business or investment property. If the properties are not simultaneously exchanged, the time limits for deferred exchanges (6.4) must be satisfied. The entire gain is deferred only if you do not receive any “boot” gain is taxed to the extent of boot received (6.3). Where gain on a qualifying exchange is deferred and not immediately taxed, it may be taxable in a later year when you sell the property because your basis for the new property is generally the same as the basis for the property you traded (5.16 − 5.20).

If you make a qualifying like-kind exchange with certain related parties, tax-free treatment may be lost unless both of you keep the exchanged properties for at least two years (6.6).

The term like-kind refers to the nature or character of the property, that is, whether real estate is traded for real estate. It does not refer to grade or quality, that is, whether the properties traded are new or used, improved or unimproved. In the case of real estate, land may be traded for a building, farm land for city lots, or a leasehold interest of 30 years or more for an outright ownership in realty. Trades of personal property are discussed in 6.2.

Filing Instruction

Depreciation of Property Received in Exchange

If you make a like-kind exchange of depreciable MACRS property (42.4) for other MACRS property, your basis for the new property is the same as the basis of the traded property. You depreciate that basis over the remaining recovery period, and using the same rate and convention (42.5) as for the traded property.

If you also paid cash as part of the exchange, you have an additional basis attributable to that investment that is depreciable as new MACRS property subject to a new recovery period.

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Personal use safe harbor for rental residence.

The IRS has provided a safe harbor (Revenue Procedure 2008-16) that allows rental real estate used occasionally as a vacation home to be treated as investment property so that it can be exchanged without endangering tax-deferred treatment. The safe harbor applies to exchanges occurring on or after March 10, 2008.

To qualify, the residence has to be owned for at least 24 months immediately before the exchange, and, in each of the two 12-month periods immediately preceding the exchange, the residence must be rented at a fair rental for at least 14 days and personal use by the owner and his or her relatives cannot exceed the greater of 14 days or 10% of the days for which the residence is rented at a fair rental in the 12-month period.

Parallel requirements apply to the residence received (replacement residence) in the exchange. The replacement residence must be owned for at least 24 months after the exchange and, within each of the two 12-month periods following the exchange, it must be rented at a fair rental for 14 days or more and the taxpayer’s personal use (including use by relatives) cannot exceed the greater of 14 days or 10% of the fair rental days during the 12-month period.

If a taxpayer expects to meet the fair rental and personal use tests for the replacement residence and based on that expectation reports the exchange on his or her return as a tax-deferred exchange, but it turns out that the tests are not met, an amended return must be filed to report the exchange as a taxable sale.

Caution

Exchanging Depreciable Realty Subject to Depreciation Recapture

Recapture provisions supersede tax-free exchange rules. Thus, if you exchange a depreciable building placed in service before 1987, depreciation recapture may apply, so check the consequences of any “recapture” element. For example, if you exchange the building for land, the recaptured amount is fully taxable as ordinary income; see 44.2.

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Losses.

If a loss is incurred on a like-kind exchange, the loss is not deductible, whether you receive only like-kind property or “unlike” property together with like-kind property. However, a deductible loss may be incurred if you give up unlike property as part of the exchange; the loss equals any excess of the adjusted basis of the unlike property over its fair market value.

Reporting an exchange.

You must file Form 8824 to report an exchange of like-kind property. If you figure a recognized gain or loss on Form 8824, you also must report the exchange on Form 8949 and Schedule D (investment property) or on Form 4797 (business property).

See below for reporting an exchange with a related party (6.6).

Property not within the tax-free trade rules:

See also 31.3 for tax-free exchanges of realty and 6.12 for tax-free exchanges of insurance policies.

Exchange of partnership interests.

Exchanges of partnership interests in different partnerships are not within the tax-free exchange rules. Under IRS regulations, tax-free exchange treatment is denied regardless of whether the interests are in the same or different partnerships.

If you made an election to exclude a partnership interest from the application of partnership rules, your interest is treated as interest in each partnership asset, not as an interest in the partnership.

Real estate or personal property in foreign countries.

You may not make a tax-free exchange of U.S. real estate for foreign real estate; by law they are not considered like-kind property. However, if your real estate is condemned, foreign and U.S. real estate are treated as like-kind property for purposes of making a tax-free reinvestment (18.23).

You may not make tax-free exchanges of personal property used predominantly in the U.S. for personal property used predominantly outside the U.S.