Like-kind exchange rules state that if you exchange property for similar property used solely for business or investment, then no tax is due at the time of the exchange provided no other property, such as cash, is received. Any gain is tax-deferred. This means that you will pay tax if you sell the new property. Properties are considered similar even if they aren’t exactly the same as long as they are related in service or use.
An example of a like-kind exchange is giving up a rental home that you own in exchange for another rental home. The key is that the items being exchanged must be considered of the same asset class. 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 addition, you must actually receive the replacement property the earlier of:
Within 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.
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.
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.
If you sold your vacant lot outright instead, 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
However, since you and Mary exchanged property, 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).