Like-to-like real estate exchanges, part three
Vail, CO, Colorado
In the first two columns in this series, we considered application of “like-kind” exchanges of real property for the purpose of deferring taxable gain and for wealth accumulation. We also considered the timing for such exchanges and complications which may be involved in accomplishing such exchanges. In this column, the focus will be on various safe harbors which may be employed to accomplish the exchange in compliance with applicable regulations.
What the taxpayer wants to avoid in the exchange of one parcel for another is receipt of the proceeds of the sale because the money, if received by the taxpayer, will be subject to capital gains tax. To avoid ” actually, to defer ” the gain, the taxpayer can instead “exchange” certain kinds of property for another, using a qualified intermediary. In this way, the taxpayer will not have use or control the proceeds.
As discussed in the first two columns, the rules allow the taxpayer relinquishing one property to acquire another from a person or entity who is not strictly “trading” properties with the taxpayer, so, strictly speaking, the transaction is not really an “exchange.” This flexibility allows the seller of the property the taxpayer wishes to acquire to transfer that property to a qualified intermediary without having to take the property the taxpayer is selling in return. To the seller of that property, the transfer is, for all intents and purposes, an outright “sale.”
In most instances, the taxpayer will not feel secure going forward with the proposed exchange based solely the on the other parties’ to the transactions promises that they will “perform.” In other words, the taxpayer wants some security that the buyer will buy the property the taxpayer is giving up and that the seller will sell before the taxpayer commits to the exchange. Securing these promises is essential so that the taxpayer cannot be construed to have “received” the proceeds of the sale and thus be subject to a capital gain.
To protect the taxpayer from receipt of the proceeds, four “safe harbors” have been recognized. These safe harbors include security or guarantee agreements, qualified escrow accounts, qualified trusts and qualified intermediaries. In essence, each of these vehicles shield the taxpayer from liability for a taxable gain. The distinctions between each of these vehicles is beyond the scope of this column. Suffice it to say that each, if followed to the letter, will provide protection from taxes. In practice, most taxpayers opt for the tried and true vehicle, use of a qualified intermediary.
Under this structure, a third party acts as a depository into which the exchanged properties are placed. The intermediary acquires the exchanged property from the taxpayer and then sells it to the buyer. Similarly, the intermediary acquires the exchanged-for property and transfers it to the taxpayer. As you might suspect, the qualified intermediary must meet certain qualifications and follow certain specified procedures in order to comply with the rules pertaining to like-for-like exchanges.
Typically, the qualified intermediary will be a title company, an independent exchange service specializing is such exchanges, or an attorney.
Provided that all rules are strictly complied with, the taxpayer will not be in receipt of the proceeds of the sale and will have therefore not be subject to taxes.
The intermediary will not appear in the property’s chain of title.
In this way, taxes can be deferred, in some instances indefinitely, increasing the taxpayer’s wealth and holdings. Although the procedure is seemingly unnecessarily complicated, in competent hands, compliance with the rules is, generally speaking, straightforward and may prove well worth the relatively small expense and effort.
Rohn K. Robbins is an attorney licensed before the Bars of Colorado and California who practices in the Vail Valley. He is a member of the Colorado State Bar Association Legal Ethics Committee and is a former adjunct professor of law. Robbins lectures for Continuing Legal Education for attorneys in the areas of real estate, business law and legal ethics. He can be heard on Wednesdays at 7 p.m. on KZYR radio (97.7 FM) as host of “Community Focus.” He can be reached at 926-4461 or at email@example.com
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