How Does A Like-Kind Exchange Work?

The exchange of property for the same kind of property is the most common type of nontaxable exchange. To qualify as a like-kind exchange, the property traded and the property received must be both of the following.

• Qualifying property.
• Like-kind property.

The basis of the property you receive is generally the same as the basis of the property you gave up. If you trade property in a like-kind exchange and also pay money, the basis of the property received is the basis of the property you gave up increased by the money you paid.

Qualifying property. In a like-kind exchange, you must hold for investment or for productive use in your trade or business both the property you give up and the property you receive.

Like-kind property. There must be an exchange of like property. The exchange of real estate for real estate or personal property for similar personal property is an exchange of like property.

Example. You trade in an old truck used in your business with an adjusted basis of $1,700 for a new one costing $6,800. The dealer allows you $2,000 on the old truck, and you pay $4,800. This is a like-kind exchange. The basis of the new truck is $6,500 (the adjusted basis of the old one, $1,700, plus the amount you paid, $4,800).

If you sell your old truck to a third party for $2,000 instead of trading it in and then buy a new one from the dealer, you have a taxable gain of $300 on the sale ($2,000 sale price minus $1,700 basis). The basis of the new truck is the price you pay the dealer.

Partially nontaxable exchange. A partially nontaxable exchange is an exchange in which you receive unlike property or money in addition to like property. The basis of the property you receive is the total adjusted basis of the property you gave up, with the following adjustments.

1) Decrease the basis by the following amounts.
    a) Any money you receive.
    b) Any loss you recognize on the exchange.

2) Increase the basis by the following amounts.
    a) Any additional costs you incur.
    b) Any gain you recognize on the exchange.

Allocation of basis. Allocate the basis first to the unlike property, other than money, up to its FMV on the date of the exchange. The rest is the basis of the like-kind property.