|
|
|
|
 |
|
Like-Kind Exchange: Selling and Reinvesting without Tax A like-kind exchange is still an attractive option for lowering your tax bill on appreciated property The words "tax shelter" have all but left the American vocabulary. The continuing stream of congressional tax legislation has nearly eliminated the ability to create tax deductions today in exchange for in-come in the future. But at least one significant opportunity to defer gain – the like-kind exchange – is still available, and it offers surprising flexibility. The concept seems simple. You have an appreciated asset that you want to sell. Rather than recognize a large taxable gain, you exchange the property using the like-kind swap rules found in IRS Code § 1031. This is great in theory, but what do you do when the buyer doesn’t own what you consider suitable replacement property for exchange? Here’s where the flexibility comes into play. Margaret’s story. Margaret owned a parcel of land that had been in her family for many years. It had produced modest rental income, but its real value was its potential for urban development as the nearby city expanded. Recently, a developer appeared, offering a large cash buyout at a very good price but demanding quick action. After analyzing Margaret’s objectives, we advised her to transfer title in the property to a qualified intermediary, in ex-change for an agreement to return acceptable like-kind property. (A qualified intermediary is simply a party, such as an attorney or realtor, who has no prior business or blood relationship with the property owner.) The qualified intermediary then sold Margaret’s property for cash, while Margaret’s realtor began searching for re-placement property. Eventually, suitable commercial real estate was located, and the qualified intermediary used the cash to acquire the property on Margaret’s behalf. He then completed the exchange by transferring the deed to her. From Margaret’s standpoint, it had been a pure exchange: A deed for land was surrendered and a deed for a commercial building was received. Margaret needed to add a few dollars to complete the purchase, and there were some transaction costs, but they were a fraction of the taxes that Margaret would have faced on an outright sale. With gain deferred in this manner, Margaret’s tax cost in the old property carried forward to become her tax basis in the new property. Time limits. You might conclude from the prior example that the like-kind exchange rules are very liberal. With respect to what is like-kind real estate, that is true. Bare land and improved property are interchangeable, as long as the property is held for either business or investment reasons (as op-posed to personal or vacation use). This allowed Margaret to exchange investment land, that produced a few dollars of rent, for a substantial, professionally managed commercial building, yielding a solid retirement income for her. The more severe restraint has to do with the time limits in completing deferred exchanges. From the time Margaret surrendered her land to the qualified intermediary, she had only 45 days to identify potential re-placement properties. Further, she had to complete the exchange within the earlier of (a) 180 days after the transfer of the relinquished property or (b) the extended due date of the tax return for the year in which the transfer occurred. Thus, if Margaret deeded her land to the intermediary in early July, within 180 days she must have received a deed to close the transaction and preserve the tax-deferred exchange treatment. Conclusion. The deadlines described above can complicate an exchange, but they are not prohibitive in most cases, and they should not deter you from seeking a like-kind exchange if it will help you achieve your tax-saving goals. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |