Duvall & Associates, Inc.
BUSINESS ADVISOR NEWSLETTER
 

An Exchange of property may be better than cash if you want to see tax savings

- by Alan Duvall 

Published in Dayton Daily News May 21, 2006 

Follow the money - an axiom that crystallizes a great deal of the intricate mysteries of tax law. 

Sell an asset for cash and you are immediately taxed on the difference between sales price and the asset’s cost basis.  Don’t want to pay taxes on the sale?  Consider a trade of your property for another like kind asset. 

No gain or loss is presently recognized if business or investment property is traded solely for like kind property.  Instead the cost basis of the sold property is transferred to the new property.

For Example – Investment land with an original $40,000 cost is traded for an apartment building worth $100,000.  No gain is currently recognized on the transaction and the owner assumes a $40,000 cost basis for the new building. 

Why this happens: No cash was received and the government will patiently get its taxes when the new property is eventually sold. 

Gain is only recognized to the extent of cash received in the deal.  In the above example, if the landowner received $10,000 in addition to the building, gain equal to the cash would be presently taxed.

Loss on the exchange is also not recognized which may not be a good thing.  To illustrate, if a business auto with a $20,000 cost basis is given a trade-in value of only $5,000 the ability of the owner to deduct the resulting loss would be forestalled by the trade.  Consider outright selling the car for cash – deduct the loss – and buy the new auto as a separate transaction. 

Both traded properties must be held for business or investment purposes.  Thus, purely personal assets such as residences are not eligible for this tax game.  Other excluded assets include trade inventory as well as stocks & bonds.   

Exchanged assets must be of a like kind.  Definitional rules are lenient for real estate – land for buildings, farms for urban condos may qualify.  Condition is irrelevant – new for used property qualify.  Farmers beware – livestock must be of the same sex to be of like kind – so check those heifers and steers.    

The exchange does not necessarily have to be simultaneous.  An exchange may qualify if substitute property is identified within 45 days and effectively acquired within 180 days of the original sale date.  Such delayed exchanges generally involve use of independent escrow agents holding sales money to be used in the acquisition of replacement property.  Be careful with these arrangements – the IRS demands strict compliance with “parking” scenarios for the two transactions to be treated as one exchange. 

Cash may be King – but if you want to avoid current tax on sale gains - consider an exchange of assets.

Alan Duvall is a certified public accountant in Dayton.  Contact him at Alan@Duvallcpa.com.