Like-Kind Exchange FAQ

Like Kind Exchange FAQ What is Like Kind Exchange? It is a process that offers a tax benefit based on provisions of the "Internal Revenue Code Section 1031. This tax rule allows deferral of tax payments on capital gains generated by the sale of business assets which are in turn replaced with like kind business assets.

What is Gain?

Under the Internal Revenue Code section 1222, gain or loss from sale or exchange of a capital asset is a capital gain or loss. Per IRS Publication 544

Basis. You must know the basis of your property to determine whether you have a gain or loss from its sale or other disposition. The basis of property you buy is usually its cost. However, if you acquired the property by gift, inheritance, or in some way other than buying it, you must use a basis other than its cost.

Adjusted basis. The adjusted basis of property is your original cost or other basis plus certain additions and minus certain deductions, such as depreciation and casualty losses. In determining gain or loss, the costs of transferring property to a new owner, such as selling expenses, are added to the adjusted basis of the property.

Accelerated Depreciation. The Modified Accelerated Cost Recovery System depreciation methods yield greater expenses in the early years of asset life. Therefore, sale of an asset for less than the purchase price may generate taxable gain after only a few years.

What is the benefit of Like Kind Exchange?

Deferred gain recognition. Payment of taxes due on capital gains may be deferred indefinitely. Reduced taxation frees cash for investment, more competitive pricing or reduces borrowing. All in all, LKE can be a smart strategy.

Is Like Kind Exchange difficult?

Setting up a Like Kind Exchange program does require a degree of effort in order to comply with the IRS requirements. However, meeting these requirements is has been accomplished by numerous taxpayers and does not intrude on business operations once the initial work is finished.

What are the risks?

Like Kind Exchange programs have been established in a variety of businesses over many years. Given that the program is properly established and operated there is no apparent increased risk of IRS audit or business interruption.

What does the Red Moon Solutions product do for me?

  • Documentation: The IRS requires very specific documentation for each exchange.
  • Depreciation Calculations: Depreciation and gain calculations for exchanged assets differ considerably from those for conventional assets. These calculations also change quite often at the whim of congress.
  • Tax Reporting: All the information used to incorporate Like Kind Exchange program activity into federal tax returns is available from system reports.

Like Kind Exchange Program Monitoring: The application provides the information necessary to track matches, monitor data quality, and predict replacement needs.

What role does a qualified intermediary play in the process?
The like kind exchange rules permit the taxpayer to defer recognition of gain by contracting with a qualified intermediary to conduct sales of relinquished property and purchases of replacement property. Under their "Exchange Agreement", upon the disposition of an asset, the qualified intermediary is required to sell all property that the taxpayer previously owned and depreciated. The qualified intermediary 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 qualified intermediary will use to make up the difference.

What additional details can be provided concerning the RMS Like Kind Exchange Process?

Step One: Batch extract and load
The Like Kind Exchange application performs the like-kind exchange matching process through batch extraction and load of data from the client’s production lease accounting, rental management, or other proprietary fixed asset management application. The extract file is typically a source text file and provides like-kind properties and their attributes. Import controls and data integrity checks along with a control file is used to verify that data is imported accurately, with designated ".log" files generated by the import process to provide audit trail.

Step Two: Data Update
Once the initial file loading process is completed, the application updates the tables with any new information imported. Once all updates have been made, the application determines the matching eligibility of all of the assets in the system.

Step Three: Property Matching
After all assets have been marked as eligible or ineligible for matching, the matching process begins. During this process, the application first tries to match as many relinquished assets as possible to available replacement assets, and then tries to match any replacement assets. Once all of the above procedures are complete, the extract file and control file are placed in a History file along with corresponding audit trail and a data integrity report.

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