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Like Kind Exchanges

Savvy investors know that Internal Revenue Code (IRC) Section 1031 provides a vehicle for deferring capital gain taxes while disposing of investment property.  The United States Treasury Department has validated the services of a "Qualified Intermediary" to complete a tax deferred exchange.

Thanks to the IRC 1031, a properly structured exchange allows an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes.  IRC 1031 (a) (1) states:

No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business of for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.

Pursuant to IRC 1031, capital gain deferment requires the exchange of "like-kind" relinquished property for other "like-kind" replacement property.  Any real property held for investment or real property used in a trade or business can be exchanged for any other real property held for investment or any real property used in a trade or business.

To fully defer all capital gain taxes, an Exchanger must meet two requirements:

  1. Reinvest all exchange proceeds.
  2. Acquire property with the same or greater debt.

Always discuss a 1031 tax deferred exchange with your tax and/or legal advisors.  You should also include verbiage stating the intent to perform a 1031 tax deferred exchange in the Purchase and Sale Agreement:

"Buyer is aware that Seller intends to perform an IRC 1031 tax deferred exchange.  Seller requests Buyer's cooperation in such an exchange and agrees to hold Buyer harmless from any and all claims, liabilities, costs or delays in time resulting from such an exchange.  Buyer agrees to an assignment of this contract to Asset Preservation, Inc., by the Seller."

The most common type of exchange is a delayed exchange which typically happens as follows:

1.   Sale of Relinquished Property

Prior to closing the sale of the relinquished property, the Exchanger enters into the Exchange Agreement with a Qualified Intermediary.  Pursuant to the Exchange Agreement, an Assignment is executed prior to closing, and Qualified Intermediary assumes the Exchanger's Purchase and Sale Agreement.  The Qualified Intermediary instructs the closing/escrow officer or closing attorney to directly deed the property from the Exchanger to the buyer.  Proceeds are transferred directly to the Qualified Intermediary, thereby protecting the Exchanger from actual or constructive receipt of funds.  Please note that 1031 Regulations mandate restrictions on the Exchanger's ability to access exchange proceeds at any time.

2.   Identification of Replacement Property

The Exchanger must properly identify potential replacement properties within 45 calendar days.  The are regulations which allow you choose a number of potential replacement properties.  Please speak to your lawyer or tax advisor for more information.

3.   Purchase of the Replacement Property

The Exchanger has a total of 180 calendar days from closing of the relinquished property, or their tax filing date, whichever is earlier, to acquire "like-kind" replacement properties.  Prior to closing on the replacement property, the Exchanger assigns the Purchase and Sale Agreement to the Qualified Intermediary.  After the Assignment is executed, the exchanger is completed when the Qualified Intermediary purchases the replacement property with the exchange proceeds and transfers it back to the Exchanger by a direct deed from the seller.


The Delayed Exchange

A delayed exchange is the most common exchange format, providing investors the flexibility of up to a maximum of 180 days to purchase a replacement property.  The use of a Qualified Intermediary is required to complete a valid delayed exchange.  (This process is further explained above.)

The Simultaneous Exchange

Most investors today use a Qualified Intermediary to safely facilitate a simultaneous exchange.

The Improvement Exchange

Improvement (build-to-suit or construction) exchanges allow an investor to use exchange proceeds to either (1) make improvements to an existing property or (2) build a new replacement property.

The Reverse Exchange

A "reverse exchange" is the purchase of the replacement property prior to closing on the relinquished property.

The Personal Property Exchange

Exchanges of personal property, such as aircraft or business equipment, can qualify for tax deferral.

Whenever contemplating a "Like Kind" Exchange, make sure that you contact your lawyer or tax advisor.  Unless you strictly comply with all of the relevant I.R.S. rules and regulations, your contemplated exchange may not qualify and you may be subject to significant taxes, penalties and interest.

This web site is designed for general information only.  The information presented at this site should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.  Persons accessing this site are encouraged to seek independent counsel for advice regarding their individual legal issues.