Like Kind Exchange 

In a normal transaction of a property, the property owner is taxed on any profit realized from the sale. However, through a Section 1031 Like Kind Exchange, the tax on the gain can be deferred until some future date. As per Section 1031 of the Internal Revenue Code, no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. This means that properties such as land, building, vehicles, cattle etc. can be exchanged for another like-kind property and defer taxes indefinitely. Because of such a facility of deferring taxes, many companies opt for IRS 1031 like kind exchange processes every year.

A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of ""like-kind"", while deferring the payment of federal income taxes and some state taxes on the transaction. It must be clearly understood that the like-kind exchange under Section 1031 is tax-deferred and not tax-free. When the replacement property is ultimately sold without any exchange the original deferred gain and any additional gain realized since the purchase of the replacement property, is subject to tax.

One of the terminologies commonly used in the IRS 1031 exchange law is like-kind. Like-kind indicates property type and not the property value. In this, properties similar in nature only can be exchanged. For example, exchanges are possible between independent residential buildings to apartment buildings, vehicle to vehicle, cattle to cattle etc. This obviously means that building cannot be exchanged to vehicle; car cannot be exchanged for land and so on and so forth. As indicated earlier, there is no restriction on the value of the exchanged property except that in case if the value of exchanged property is less than the property sold it is considered as profit and hence taxed. Hence, it is necessary that the exchange property has to be of equal or higher value.

As per this law there is no problem in purchasing a higher value property using the sale proceeds of the original property. In such a case there is no profit due to the sale of original property since full amount of sale is utilized for purchase of a new property. This means no tax is payable immediately on this sale. However, this tax is deferred. The sale money can fully be utilized for down payment to a new property which allows the person to borrow further and purchase a better property.

A sample calculation for a normal transaction and transaction based on IRS 1031 exchange law sale are given below.

Normal sale

Sale value of the original property - $100000 Normal tax applicable on this sale - $35000 Net of tax amount on hand for down payment - $65000 Down payment made (Nett amount on hand) – 25% Loan eligibility - $260000 Purchase Property value – $325000

IRS 1031 exchange law sale

Sale value of the original property - $100000 IRS 1031 exchange law tax on this sale - $0 Net of tax amount on hand for down payment - $100000 Down payment made (Nett amount on hand) – 25% Loan eligibility - $400000 Purchase Property value – $500000

The above figures indicate that you could purchase a property worth $500000 using IRS 1031 like kind exchange law sale against $325000 for a normal sale. This means that there is an increase in the property value to the extent of $175000 and this would enable the person to purchase a higher value property.