written by Eric Lampe

Under Code Sec. 1031, a taxpayer can make a tax-free exchange of property held for productive use in a trade or business or for investment. The exchange must be made for other property that the taxpayer will continue to use in a trade or business or for investment. Ordinarily, the exchange is made directly with another taxpayer who holds like-kind property. For example, an investor in real estate may exchange a building with another person who also owns real estate for use in a trade or business or for investment.

This is accomplished by most of us when trading in of an old vehicle or other machinery when purchasing new. When you trade in a vehicle, the vendor is in essence purchasing that vehicle from you in the form a trade in price. If you have held that vehicle for many years it has probably been fully depreciated, meaning that the entire trade in price is taxable. Code Sec. 1031 allows you to defer that gain from taxes and assigns the gain to the new asset.

Scenario: You have a company truck that you purchased 7 years ago. This item has been fully depreciated when you trade it in on a new truck. The dealership gives you $10,000 trade in price. Normally, when you sell that asset, you would pay taxes on $10,000, but since you traded it in, you pay no taxes on the $10,000 in the current year, and the $10,000 gain gets amortized over the life of the new truck.

Another way to take advantage of Code Sec. 1031 is to make a deferred like-kind exchange, using a third person to facilitate the exchange. This can be advantageous when the taxpayer cannot find another holder of like-kind property to make a direct exchange with. The taxpayer identifies a third person to act as a qualified intermediary (QI) and enters into a legal agreement with them. The QI then acquires from the taxpayer the property that the taxpayer is relinquishing and sells the property to another person identified by the taxpayer. As part of the transaction, the QI acquires legal title to the property and transfers it to the person buying the property.

Please contact us if you have any questions about deferring taxes on business equipment 417-881-0145.