What is a Like-Kind Exchange (Section 1031, Form 8824, Like-Kind Exchanges)? How do I enter it in Drake Tax?
A like-kind exchange, also known as a Section 1031 exchange, is a way of trading or exchanging assets and, in many cases, deferring gain on the trade (or exchange). “Like-kind” means that the property you trade must be of the same type as the property you receive.
Due to changes to Section 1031 exchanges listed in the Tax Cuts and Jobs Act (see page 70), any like-kind exchanges taking place after December 31, 2017 may generally only include real property.
Real Property for Real Property, such as:
- City property for farm property
- Improved property for unimproved property
- Real estate for real estate lease that runs 30 years or longer
- Remainder interest in real estate for a remainder interest in other real estate
- Land for land
- Building for building
- Land improved with a store building for land improved with an apartment building
In Drake17 and prior Personal Property (or personalty) for Personal Property, such as:
- Office furniture, fixtures, and equipment
- Information systems, such as computers and peripheral equipment
- Data handling equipment (except computers)
- Airplanes (airframes & engines), except those used in commercial or contract carrying of passengers or freight, and all helicopters (airframes & engines)
- Automobiles and taxis
- Light general purpose trucks
- Heavy general purpose trucks
- Railroad cars and locomotives except those owned by railroad transportation companies
- Tractor units for use over the road
- Trailers and trailer-mounted containers
- Vessels, barges, tugs, and similar water-transportation equipment, except those used in marine construction
- Industrial steam and electric generation or distribution systems
Some property does not qualify for like-kind exchanges, such as:
- Property you use for personal purposes
- Stock in trade or other property held primarily for sales (such as inventories), raw materials, and real estate held by dealers
- Stocks, bonds, notes, or other securities, or evidence of indebtedness (accounts receivables)
- Partnership interests
- Certificates of trust or beneficial interests
If it’s a straight-up exchange (asset-for-asset), more than likely no gain would be recognized from the exchange (or trade). You would have the same basis in the new asset as you had in the asset you traded. While you may not have to recognize any gain on the exchange, you still need to report it on Form 8824.
Frequently, not all properties are equal in value, so either cash or other property (non-like-kind) is included in the trade. This other property or cash is known as boot. If boot is involved, you will have to recognize some gain, but only up to the amount of boot you receive in the exchange. Your basis in the property you receive is equal to the basis in the property you gave up minus the amount of boot you received plus the amount of gain recognized.
Basis of Property Given Up
- Cash or Other Property Received
+ Gain Recognized
Total Basis of Property Received
Note that you will also never recognize more gain than your actual realized gain on the exchange.
If the asset you are trading is subject to a debt (or liability) and the other party involved in the exchange is assuming your debt (relieving you of it) it is as if you received cash in the amount of the liability. This debt is also treated as boot. If you assume the other party’s debt and he assumes yours, you are only treated as receiving boot by the amount of the debt you have exceeds the debt you pick up.
Form 4797 Not Generating
Form 4797 will only generate if there is realized gain on the exchange. Per the 8824 Instructions, "Generally, if you exchange business or investment real property solely for business or investment real property of a like kind, section 1031 provides that no gain or loss is recognized. If, as part of the exchange, you also receive other (not like-kind) property or money, gain is recognized to the extent of the other property and money received, but a loss isn't recognized." Per the 4797 Instructions, "...enter the gain or (loss) from
Form 8824, if any, on Form 4797, line 5
or line 16."
See Publication 544, Sales and Other Dispositions of Assets, for more information.
Here are the steps for entering a like-kind exchange:
- On the 4562 screen for the asset that you traded (or gave up), add an identifier so that you can easily recognize that the asset was involved in a like-kind exchange.
- For example, if you traded a single family home and in exchange received a duplex, you might want to enter the description of the asset you gave up as "8824- single family home."
- Go to the 8824 screen and enter the like-kind exchange:
- Other property given up represents property that you gave up in addition to the single family home (in this example).
- Other property received represents any cash paid to you by the owner of the other property, the fair market value (FMV) of any property you received in addition to the new asset, and any liabilities assumed by the owner of the new asset.The sum of these amounts would be reduced by any exchange expenses you incurred.
- Like-kind property received tracks the FMV of the exchange property you received and the adjusted basis of the like-kind property you gave up.
- Note: The adjusted basis would include the sum of the adjusted basis of the property you gave up, any exchange expenses (if not used in the Other property received figure), and any amount of cash you may have paid the other party in addition to the like-kind property.
- Once you have entered all applicable information on the 8824 screen, calculate the return and view Form 8824. Look at the line marked Basis of like-kind property received. Generally, this becomes the adjusted basis of the new asset, unless there was an additional amount incurred in obtaining it.
- There are two options for the next step, depending on whether you are using the like-kind exchange rule (A) or electing out of the like-kind exchange rule (B). Details on what the like-kind exchange rule is can be found in Publication 946, page 42.
A. Using the Like-Kind Exchange Rule
Generally, you would continue depreciating the old asset unless you elect out of the like-kind exchange rule. In this circumstance, do not enter anything in the If sold section of the 4562 on the original asset. Create a new 4562 screen for the new asset that shows only the cost of the new asset plus any additional amount paid to obtain it (the amount shown in step 3 above).
- For example, if you traded the single family home plus $4,000 for a duplex, the extra $4,000 you paid would become the cost for the duplex entered on the 4562; the date placed in service would be the date of the trade.
B. Electing Out of the Like-Kind Exchange Rule
If you are electing out of the like-kind exchange rule,
- Enter the date of the transaction in the If sold section of screen 4562 for the asset given up under Date Sold.
- Enter the corresponding Multi-form code in the Like Kind Exchange MFC box to indicate that this asset is included on the 8824 screen (for the first LKE, enter a 1). (In Drake16 and prior, indicate this by choosing LK for the Property Type).
- Enter a new 4562 screen for the asset received.
- The cost would include the adjusted basis of the old asset, the cost of the new asset, and the extra amount paid to obtain it.
- For example, if you traded the single family home plus $4,000 for the duplex, the cost of the new asset would be the sum of the single family home cost, plus the cost of the duplex, plus $4,000.
- Attach a statement that indicates you are electing out of the like-kind exchange rule.
- This statement must indicate that the Election was made under section 1.168-6(i) for each property involved in the exchange.
- The election must be made on a timely filed return.
- The election can only be revoked with the consent of the IRS.
- In an individual return, you can make the election on the ELEC screen. Use the Other description field in the lower-right corner, which produces an ELECTION note that e-files with the return.
- In business returns, there are two options:
- Enter an SCH screen to attach an EF Note with this statement.
- Open the ELEC screen, use the general election statement, and enter an explanation in the space provided.
For more information on how to depreciate assets involved in a like-kind exchange, see Publication 946, or the Instructions for Form 4562. For more information on figuring the basis of assets, refer to Publication 551.
For Drake17 and prior, special rules exist for vehicles acquired in a trade-in. See Publication 946, for more information. Starting in Drake18, generally only real property can qualify for a like-kind exchange.