Real estate exchanges: Part 2
Vail, CO, Colorado
With an eye toward the developing Scoop Daniel scandal, we embarked last week on a three-part journey into understanding “like-kind,” real estate exchanges.
In the prior column, we considered application of like-kind exchanges for the purpose of deferring taxable gain and for wealth accumulation. In this column, we consider timing of the exchange and some potential complications.
As you may recall, section 1031 of the Internal Revenue Code allows for deferral of the taxable gain in exchanges of real property held for productive use in a trade or business or investment for other similar real property.
The advantage is that taxes will not have to be paid at the time of the exchange as they would if the property was sold. Intermediaries are usually employed as “depositories” for the exchanged properties, relieving the taxpayer from the burden of having to find someone who wants to trade. Instead, he or she can acquire another property from another person or entity whose sole desire is to “sell” his or her property.
All about timing
The timing of the exchange is critical and the rules pertaining to the exchange are strictly enforced. The tax code rules do not require that the “like-kind” exchange occur simultaneously. However, the exchange must take place within a specific period of time. To qualify under the rules, the taxpayer must identify the “exchanged-for” property no later than 45 days after relinquishing the “sold” property. Additionally, the taxpayer must “close” on the new property on the earlier of 180 days after the taxpayer transfers the exchanged property or the due date (including any extensions) of the taxpayer’s tax return for the year in which the exchange takes place.
The exchanged-for property is “identified” by the taxpayer designating the property as the “replacement property” in a written document signed by the taxpayer and sent within the 45-day identification period, generally to the person or entity obligated to transfer the exchanged-for property.
To designate the exchanged-for property, the taxpayer must describe the property in a written document with sufficient precision to distinguish it from all other properties. This can usually be accomplished by reciting its legal description or, less precisely, its street address.
Despite this precision, and, perhaps in recognition of the fact that deals take time to make and may fall through, Treasury Regulations allow a taxpayer to identify more than one exchanged-for or “replacement” property. The benchmark number of properties which may be “identified” is three. This too, however, is subject to exception.
If the aggregate value of exchanged-for properties does not exceed 200 percent of the aggregate fair market value of the exchanged or “relinquished” property (or properties) as of the date the taxpayer transferred them, then the number of properties which may be “identified” may be greater than three. As a footnote, or perhaps an exclamation point meant to perplex, the Regulations allow like-kind requirements to have been met so long as the taxpayer closes on an “identified” property or properties with an aggravate fair market value equal to at least 95 percent of the fair market value of the exchanged property or properties.
Now, catch your breath. Multi-unit properties may present special problems.
If a taxpayer wishes to designate a multi-unit property, such as an apartment complex, he or she may be wiser to avoid the three-property rule altogether and, instead, to rely on the 200-percent rule or, if applicable, the 95-percent rule.
Essentially, this is because the regulations do not make sufficiently clear whether a multi-unit property represents however many units there are, or if instead, the units are to be taken as an “entity” and, for purposes of the exchange, considered to be a single property.
One further thing to consider; the Regulations do allow identification of a property under construction so long as it meets all other requirements such as sufficient “identification.”
In the final column in this series, we will deal with “reverse” exchanges, various “safe harbors” and other related aspects of like-kind tax-deferred “exchange” under the IRS rules.
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.” Robbins can be reached at 926-4461 or by e-mail at email@example.com