If you own real estate that has appreciated in value, you may owe a sizeable capital gains tax when you sell. But tax law provides a way to postpone the tax. Here’s how: Instead of a sale, you can swap your property for another property of a similar character in a transaction called a “like-kind exchange.” To qualify, you’ll need to meet specific conditions, such as completing the transaction within a certain period of time and making sure the property qualifies.
Two of the timing requirements are strict. First, you must identify or actually receive the replacement property within 45 days of transferring legal ownership of the relinquished property. And second, you must receive title to the replacement property by the earlier of 180 days or your tax return due date, plus extensions, for the tax year of the transfer. Be aware of the second rule if the exchange will straddle tax years. Why? When you relinquish real estate late in the year, you might want to apply for a filing extension if you need more time to wrap things up.
The rules are fairly lenient as to what constitutes “like-kind property.” As an example, you might exchange an apartment building for a warehouse or raw land. However, both the relinquished and replacement real estate must be used as investment or business property. The like-kind tax break doesn’t apply to swaps involving a personal residence.
Like-kind exchanges may involve multiple parties, as it’s unusual for you and a single real estate owner to each own property the other wants. In some cases, you might arrange for an individual who is in the business of making these exchanges work (known as a “qualified intermediary”) to help consummate the deal. The end result is the same: You give up property and receive like-kind property in exchange.
Keep in mind that you’ll generally owe tax on any excess value, called “boot,” that you receive in the deal. Boot can be more than just cash — for instance, it might represent partial forgiveness of a mortgage. If you’re the one giving the boot, you realize no taxable income.