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LIKE-KIND EXCHANGES: ANCIENT AND ACCEPTED

January 28, 2003

While Section 1031 exchanges haven't been around as long as the Masons, they have been around quite awhile. The precursor of the current like-kind exchange rules was enacted in 1918, only five years after the income tax took effect. Properly executed, a like-kind exchange provides a real-life way to avoid taxes without going offshore or to jail.

WHAT QUALIFIES? You can exchange any "like-kind" property that has been "held for investment" or for "use in a trade or business" for other "like-kind" property that will be held for investment or use in a trade or business. Personal-use property does not qualify.

Certain items can never be exchanged under Section 1031. These include

-Inventory
-Stocks, bonds, notes, indebtedness, or other securities
-Partnership interests
-Choses in action
-Interests in trusts.

WHAT IS "LIKE-KIND?" In general, real estate is typically like-kind to other real estate. For example, a farm is like-kind to an apartment building. Personal property is more complicated. Two items are generally like-kind if they are in the same "general asset class" of Rev. Proc. 87-56, or if they are in the same 4-digit "product class" of Division D ("Manufacturing") of the Federal listing of Standard Industrial Codes.

But beware: livestock of different sexes are never "like-kind."

WHAT ARE THE BENEFITS OF A SECTION 1031 EXCHANGE? No gain is recognized on like-kind exchanges made solely for like-kind property. The basis of the property given up becomes the basis of the property received; as a result, the gain is deferred until the property received in the exchange is itself sold.

BUT DON'T TRY THIS AT HOME! There are any number of foot-faults that can cause a like-kind exchange to fail. We will discuss some of these problems, and some ways around them, in upcoming issues.

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