Q We have a rental condo in San Jose and are considering a like-kind exchange for a rental property closer to home in Monterey. We would like to get a local “starter” house or condo for our grandson. What are the general rules for tax-free exchanges?

A Gains from exchanges of property are generally recognized for tax purposes, as are gains from sales of property. However, some types of exchanges do not give rise to taxable gain or deductible loss where there is merely a change in form of the property exchanged.

No gain or loss is recognized upon the exchange of property held for productive use in a trade or business, or for investment, if the property received is of a like kind and is held either for productive use in a business or investment. This type of transaction has become known as a Starker exchange or a Section 1031 exchange. This rule does not cover inventories or other property held primarily for sale, stocks, bonds, notes, certificates of trust, beneficial interests, partnership interests, securities or evidences of indebtedness. Federal Form 8824 is used to report like-kind exchanges.

Like-kind property is defined as property of the same nature or character. Most, if not all, exchanges of real properties (buildings, land, etc.) qualify as like-kind exchanges. An exchange may qualify for like-kind treatment even if the replacement property is received after the relinquished property has been transferred by the taxpayer, provided that the following identification and receipt requirements are satisfied. After transferring the relinquished property, the taxpayer must identify replacement property (or properties) within 45 days and must receive the replacement property (or properties) within 180 days. A taxpayer may identify up to three replacement properties or may identify any number of replacement properties if their aggregate value does not exceed 200% of the aggregate value of all relinquished properties.

The taxpayer may not actually or constructively receive cash and then use the proceeds to buy the replacement property. Four safe harbors protect non-recognition treatment in a deferred like-kind exchange in which a property or security interest is received by the transferor. The transferor is not considered in receipt of money or other property if the transaction involves (1) qualifying security or guarantee arrangements, (2) qualified escrow accounts or trusts, (3) a qualified intermediary, or (4) payment of interest.

If in an exchange of property of like kind, other (unlike) property or money is received in addition to like-kind property, gain is recognized, but only up to the sum of money and the fair market value of the other property received. Under no circumstances may a loss from a similar exchange be deducted.

Monterey resident Barry Dolowich is a certified public accountant and owner of a full service accounting and tax practice with offices in Monterey. He can be reached at (831) 372-7200. Please address any questions to Barry at P.O. Box 710 Monterey, CA 93942-0710 or email: bdolowich@gmail.com