Like-kind exchanges and the tax rules for acquisition financing

Two different tax questions

These federal rules apply in New York. A like-kind exchange concerns recognition of gain; acquisition financing concerns borrowing costs.

Exchange eligibility and deferral

Since 2018, only real property qualifies for like-kind exchange treatment. Both properties must meet business or investment use requirements. Personal residences and property held primarily for sale do not qualify. Like kind concerns the nature of real property, not identical buildings: qualifying investment land can be exchanged for a rental building. U.S. and foreign real property are not like kind.

A qualifying exchange defers gain rather than permanently excluding it. A delayed exchange must meet identification and completion deadlines. Simply collecting sale proceeds and later buying another investment is insufficient. A qualified intermediary commonly helps structure an exchange without the taxpayer receiving the proceeds.

Cash or nonqualifying property received is called boot and can trigger gain recognition up to realized gain. Another party's assumption of the taxpayer's liability is treated as money received; offsetting debt and cash must also be analyzed.

Basis carries the deferred gain

For a simple exchange without debt, additional payment, or other property: replacement basis equals old adjusted basis minus cash received plus recognized gain. With $200,000 old basis, $20,000 cash received, and $20,000 recognized gain: $200,000 − $20,000 + $20,000 = $200,000. Market value does not replace carryover basis. Related-party exchanges have additional restrictions on subsequent dispositions and limited exceptions.

Financing and deductions

Principal repayment reduces debt; it is not an interest deduction. Qualified residence acquisition debt involves money used to buy, build, or substantially improve the residence and debt secured by that residence. A mortgage label alone does not establish deductibility. Qualified residence interest is subject to applicable limits and itemization rules.

For a noncorporate taxpayer, investment-interest deductions cannot exceed net investment income; amounts disallowed by that limit carry forward. Net investment income is investment income minus qualifying investment expenses. Qualified residence interest and interest accounted for in passive activities are excluded from this investment-interest category. Business interest follows separate rules.

Have a tax professional review the transaction before commitments are made, especially for debt, mixed uses, or related parties.