Like-Kind Exchange Example

The Red Moon Solutions Like Kind Exchange solution permits corporations with taxable gains on sales of business assets to take advantage of the tax benefits of the like-kind exchange rules and regulations under Internal Revenue Code Section 1031. These benefits allow taxpayers to defer the recognition of gain on the sale (relinquishment) of personal property. The general income tax rules provide for the realization and recognition of gain on the sale of an asset. The amount of gain equals the amount realized (proceeds) minus the adjusted basis (cost less accumulated depreciation).

For example, an asset having a five year MACRS class life and sold in its fourth recovery year will have accumulated depreciation of $23,088.

Purchase $30,000  
First Year Depreciation $ 6,000 Half Year Convention
Second Year Depreciation $ 9,600  
Third Year Depreciation $ 5,760  
Fourth Year Depreciation $ 1,728 Half Year Convention
Sale Proceeds $15,000  
Accumulated Depreciation $ 23,088  
Tax Gain $ 8,088  

As a result, the original $30,000 asset will have an adjusted basis of $ 6,912 when sold in the fourth year of life. If this asset sold for $15,000, the proceeds ($15,000) minus adjusted basis ($ 6,912) would result in a gain of $ 8,088. The tax bill, assuming a corporate tax rate of 35%, would be $ 2,831 ($ 8,088 multiplied by 35%).

Had the above asset disposition been conducted within a Like Kind Exchange program the entire $ 2,831 income tax liability would be deferred. The $ 2,831 would be available for business investment or debt reduction. The business benefit exceeds simple tax savings since the cash which the LKE program makes available is enhanced by either the business investment rate of return or reduced borrowing cost. Many businesses perform this sale and acquisition cycle hundreds or even thousands of times a year with corresponding multiples of the gain illustrated in the above example.

The like-kind exchange rules permit the taxpayer to defer recognition of gain by contracting with a qualified intermediary (QI) to conduct sales of relinquished property and purchases of replacement property. Under their "Exchange Agreement", upon the disposition of an asset, the QI is required to sell all property that the taxpayer previously owned and depreciated. The QI uses the proceeds from such a sale to purchase replacement property. Generally, the proceeds from the sale will not be enough to purchase the replacement property, so the taxpayer will fund a supplementary account that the QI will use to make up the difference.

RMS Like Kind Exchange software achieves gain deferral by matching sales of sold (relinquished) property with purchases of replacement property. As a result, unlike the example above, the taxpayer does not pay tax on exchanges that qualify for Like Kind Exchange. Going forward, the tax basis of the purchased (replacement) property is the tax basis of the sold (relinquished) property plus any additional cash used to purchase the replacement property. This amount is then depreciated and the like-kind exchange process begins anew.

Watch on YouTubesubscribe via rssTwitterLinked InFacebook
Download The New Face of Tax Data Management eBook