Many contractors, rental companies and dealers are taking advantage of Like Kind Exchange (LKE) transactions to defer taxable gains on qualified sales of used equipment. If you meet the LKE requirements, there is little reason not to use the concept if you have current taxable income to offset, or are likely to have taxable income in the near future.

While a LKE may sound like an easy thing to do, it can get very complicated. Staying in compliance can be a real challenge. There is flexibility in the process, however, giving taxpayers the ability to choose to use a LKE or have the taxable gain reflected in their taxable income.

Principles of LKEs
Here's the way LKEs work. An equipment owner can sell a business asset at a gain and defer the gain (calculated using tax depreciation) to some future date, as long as the sales proceeds are used to purchase a qualified replacement unit. The amount of the gain deferred has to reduce the tax basis in the replacement property. As a result, the depreciation deduction going forward is now lower than it would have been had the LKE not been used.

For example, say a machine is sold for $50,000 with zero tax basis (fully depreciated). A new machine is then purchased for $200,000. With a LKE, the $50,000 gain is deferred; you have a $20,000 LKE benefit; and the tax basis in the new unit is $150,000. Depreciation going forward without a LKE is $40,000 the first year vs. $30,000 with a LKE. It's a simple example, but you get the idea.

Another LKE requirement is that the sales proceeds be restricted until they are used to purchase replacement property or to pay down equipment-related debt, or are removed from the account as a taxable distribution. In the interim, they should be held by a "qualified intermediary".