Tax Tips for Reaching Your Retirement Investment Goals

byBob Leins, CPA

This article is provided by NITP, Inc. and this company conducts retirement seminars for federal employees throughout the country. 

A well known, but sometimes overlooked, way to sell investment holdings without paying tax at the time of the transaction is through the use of “like-kind” exchanges. In a like-kind exchange, investment property is “traded” for other investment property. The person transferring one piece of property receives different property but keeps the same basis as that for the old property. That way, the gain is deferred while other tax attributes are preserved.

Of particular interest are the flexible features that make a like-kind exchange an especially useful technique. First, properties do not have to be of identical type to qualify as like-kind. One caution: like-kind exchanges do not work with all types of investment property. For instance, neither stocks or bonds qualify.

Second, properties do not have to be exchanged at the same time. Therefore, it is not necessary to have already located the exchange property to make a like-kind exchange (an important consideration if the end of a tax year is looming). It is sufficient that the exchange property (or properties) be identified within 45 days after the current property is sold, and that the identified property (or properties) be received within 180 days. However, if the tax return due date for the original transfer year occurs before the end of the 180-day period, the identified property must be received on or before the tax return due date.

To illustrate how these exchanges can work, consider the following example: Sandy owns a rental property. Sandy bought the property years ago for $40,000, but today it’s worth at least $150,000. Sandy would like to sell the rental property. Sandy wants to avoid the high tax that would have to be paid if the rental property was sold and not “exchanged”.

A solution to this is referred to as a “like-kind exchange”. It would be very difficult for Sandy to find another investor to exchange properties with. However, Sandy could sell the rental property and use an “exchange agent” to hold the funds from selling the property. Sandy would then find a “replacement property(s)” of at least equal value to the property sold. Once Sandy purchases a “replacement property(s)” subject to time constraints discussed above the like-kind exchange is completed. Provided the 45/180 day rules along with other requirements are satisfied, Sandy receives the “replacement property” tax-free, with the same basis and holding period that was in the sold property.

As you can see, a like-kind exchange can be an excellent tool that can be used to achieve investment goals. Even in situations where it is impractical to arrange a completely tax-free transaction, like-kind exchanges may still reduce the immediate tax consequences of altering your investment holdings.

There are certain very specific procedures that must be done to facilitate a tax free exchange. While these procedures are not difficult, a like-kind exchange should only be considered with the aid of someone experienced with like-kind exchanges.