Ordinarily, when you sell something for more than what you paid to get it, you have a capital gain; when you sell it for less than what you paid, you have a capital loss. Both can affect your taxes. But if you immediately buy a similar property to replace the one you sold, the tax code calls that a "like-kind exchange," and it lets you delay some or all of the tax effects. The Internal Revenue Service (IRS) uses Form 8824 for like-kind exchanges.
What happens in an exchange?
A like-kind exchange doesn't eliminate taxes; it just pushes them into the future. Say you paid $20,000 for a piece of business or investment real estate and sold it for $30,000 ($30,000 - $20,000 = $10,000 capital gain). Rather than have the $10,000 profit taxed as a capital gain, the like-kind exchange allows the gain to be "passed on" to the new property used for business.
The $10,000 gain will be factored into the tax calculation when you eventually sell the new property—unless you do another like-kind exchange, in which case the gain gets passed on to the next property you buy.
When completing the form, it’s important to keep the following in mind:
• Part I of Form 8824 is where you provide details about the old property and the new property
• Part II of the form comes into play only when a like-kind exchange involves "related parties"—members of a family or entities that you have a controlling interest in.
• Part III is for reporting details about any gains or losses from the transactions that make up the exchange—this is how the IRS keeps track of your taxable gain or tax-deductible loss
• The form has a Part IV for use only by certain federal employees; it deals with conflict-of-interest rules
Both individuals and businesses—corporations, partnerships and sole proprietorships—can carry out like-kind exchanges. However, the property involved must be used for business or investment. Beginning in 2018, like-kind exchanges can only be done with real property such as a rental home.
Like-kind exchanges don't have to be exact replacements—a warehouse for a warehouse, for example—but they do have to be of the same "nature, character or class," the IRS says. Swapping a warehouse that includes land for vacant property or a factory with land would be a like-kind exchange, since all involve real property.
Exclusions and deadlines
By law, several kinds of property do not qualify for a like-kind exchange:
• Business inventory
• Stocks, bonds and other securities
• Ownership interest in a partnership business
• Certificates of trust or an interest in a trust as a beneficiary
• Rights to sue
Beginning in 2018, like-kind exchanges can only be used for real property such as real estate.
Also, like-kind exchanges carry limits on how long you have to identify and acquire a replacement property:
• 45 days from the date you sell to identify potential replacement property and notify the seller of the replacement property or your intermediary
• 180 days after the sale to complete the acquisition of the replacement property
Failing to meet these deadlines may cause the sale of the property to be recognized in the current tax year.