Like-kind exchange rules state that if you exchange property for similar property used solely for business or investment, you may completely or partially defer gain on the exchange If gain is tax-deferred, it means that you will not pay tax (in other words recognize the gain) until you dispose of the new property.
Example: You exchange a vacant lot with a fair market value (FMV) of $100,000 for another lot that Mary owns worth $125,000. When you bought your lot several years ago, you paid $55,000 for it. Since Mary’s land is worth more than yours, you pay her $25,000 to make up the difference. You did not assume any liabilities from Mary, nor did Mary assume any liabilities from you.
If you transfer your vacant lot and do not meet the like-kind exchange requirements, you would have a gain of $45,000 that you would have to report on your tax return: $100,000 (FMV of the land today) - $55,000 (Amount that you originally paid) = $45,000 gain.
However, if you and Mary qualify to treat the exchange as a like-kind exchange, you don’t need to report any gain. What is the basis of the new property that you own? Because you acquired the property in an exchange, the basis of the new property is the sum of the basis of the property that you gave up ($55,000) and the amount of cash that you paid Mary ($25,000). This means that your basis in the new vacant lot is $80,000 ($55,000 + $25,000).
Properties are considered similar even if they differ in grade or quality, but the key is that in order to be considered like kind exchange properties, the items being exchanged must be considered of the same asset class, nature, or character. An example of a like-kind exchange is giving up a rental home that you own in exchange for another rental home. For details, see IRS Publication 544, Sales and Other Dispositions of Assets.
You don’t have to receive property on the day you give up property to qualify for a like-kind exchange. However, there are strict rules regarding tax-deferred exchanges. For a deferred exchange to qualify as a like-kind exchange, you must comply with the 45-day written notice. The notice needs to identify the like-kind property that will be received in the exchange.
In addition, you must actually receive the replacement property the earlier of:
180 days (not 6 months, but exactly 180 days) of when you gave up your property, or
By the due date, including extensions, for the year that you transferred your property.
Form 8824 (, Like-Kind Exchanges,) must be prepared for all like-kind exchanges. Additionally, there are special rules regarding multi-asset exchanges made with someone you are related to. There are also rules regarding property that was once used as your personal residence or properties received that will become your personal residence. If you fall into these categories, see the Form 8824 instructions for the steps needed to record the exchange.