Those who want to sell commercial property normally
include in income any gain from the sale, even if they later purchase like-kind
property, in contrast to the pre-97 rules for sales of principal residences.. However, you can defer the tax if you structure the deal as a "like-kind" exchange rather than a sale. This will enable you to apply all of the appreciation in your property, undiminished by the tax that would otherwise be payable, towards acquiring replacement property.
To qualify for like-kind treatment, four conditions must be met:
• You must hold both the property traded and received for business or investment purposes.
• The property traded and received must not be held primarily for sale, such as inventory.
• The properties must be of like kind, e.g., real estate for real estate.
• The properties must be tangible. For example, they cannot be stocks, bonds, notes, securities, evidences of debt, or partnership interests.
The most common types of exchanges are "simultaneous" exchanges, "deferred" exchanges, and exchanges handled by intermediaries.
A simultaneous exchange is one which you trade your property for property that another party already owns, i.e., the transfers occur contemporaneously.
A deferred exchange is one in which you transfer property for the other party's promise to acquire and transfer property of like-kind to you. Deferred exchanges must satisfy two timing rules. First, within 45 days of the transfer of your property, you must give the other party written identification of the property you want to receive. Second, you must receive that property by the earlier of 180 days after you transfer your property or the due date of your tax return for the year of your transfer.
As a practical matter, I always recommend use of an escrow to handle a deferred exchange. The escrow holder or trustee cannot be a "disqualified" person such as your agent or someone who is "related" to you or your agent.
The third common way to make a like-kind exchange is to use a qualified intermediary who contracts to transfer (and acquire, if necessary) both properties. As with an escrow holder or trustee, the intermediary cannot be a disqualified person.
Here are some special rules to note about like-kind exchanges:
• The tax consequences to the other party do not affect your tax status.
• If the properties are not equal in value, one party can transfer cash or other non-like-kind property ("boot") to equalize the exchange. Although the boot is taxable to the recipient, the transaction still qualifies as like-kind.
• If you transfer a liability in the exchange, the liability is treated as cash and thus is taxable to you.
Structuring a like-kind exchange can be complex, but the tax deferral is often worthwhile.
If you want to discuss the merits of doing a like-kind exchange instead of sale, please contact us so that we can discuss your options.