Questions About Exchanges
WHY DO AN EXCHANGE?
An exchange allows real estate sellers to delay tax on the gain from sale of their property instead of paying the tax, and exchanger is able to use that money to invest in other real estate. One way to look at an exchange is as an interest-free loan provided by the government for you to invest in property.
EXACTLY WHAT IS AN EXCHANGE?
An exchange is basically a barter transaction. Rather than selling the property themselves, the exchanger contracts with an intermediary to:
(1) take title to the exchangers property
(2) sell the property to the exchanger's buyer
(3) receive and invest the proceeds of the sale
(4) purchase like-kind property designated by the exchanger, and
(5) transfer title to the exchanger.
Tax payment is avoided because the exchanger never actually receives funds from the sale. Instead, they receive replacement property.
WHAT RULES COVER EXCHANGES?
Property owners have been doing exchanges even before the well-known Starker decision in 1979. In 1990 and 1991, the Treasury finally issued rules covering exchanges. These rules give official sanction to real estate exchanges. However, they also provide certain limitations on how exchanges must be conducted. Specifically, the exchanger must designate replacement property within 45 days of sale of the exchange property. This designation most often takes the form of a letter to the intermediary, listing the addresses of up to three properties. Then, the exchanger must close the purchase of replacement property within 180 days of the original sale.
WHAT DOCUMENTATION IS REQUIRED?
The Exchange Agreement is the basic document covering any real estate exchange. There should also be an Assignment of the exchanger's interest in the contracts to sell and purchase property. The letter designating replacement property is also important, and it must be received promptly within 45 calendar days of the original sale. Finally, proper escrow documentation, in the form of Exchange Escrow Instructions, can be helpful should the exchange ever be questioned by the IRS.
WHAT SHOULD I CONSIDER WHEN CHOOSING AN INTERMEDIARY?
The Treasury regulations specifically disqualify parties that are related to the exchanger from serving as intermediary. This includes the exchanger's real estate agent, broker, accountant, attorney, investment banker, employee or anyone who has served in such capacity in the last two years. Your best protection is to use an independent professional intermediary. In addition, you need to consider the business record of the intermediary, so that you can be sure the funds will be available when needed, you can feel confident that the exchange portion of your escrow will be handled professionally, and your exchange will be properly structured and documented.
You are advised to seek the advice of an independent professional and/or your accountant when considering an exchange. These transactions can have major tax consequences.
The title company handling the sale or purchase of your property might also have an exchange service.
1031 LIKE-KIND PROPERTY
Property that is held for Productive use in a Trade or Business
Property that is held for Investment Real Estate
The ability to go from one type of property to another allows an investor to utilize the following concepts:
- Cash Flow
- Management Relief
- Increase Depreciation