Exchange of Property: The transaction must be structured as an exchange, rather than as a sale and purchase. A qualified intermediary should be involved with the sale of the relinquished property and acquisition of the replacement property. The investor must sign an exchange agreement, assignment of the purchase contract, as well as other documentation before the relinquished property sells, and the intermediary must hold the proceeds until they are used the buy the replacement property. As long as the appropriate documentation is signed, the intermediary does not need to take title to the property.
Like-Kind Requirement: The like-kind requirement is fairly broad for real property exchanges. Basically any real property held for investment qualifies as like-kind. Vacant land can be exhanged for an office building; a single family rental home can be exchanged for an office building and so on.
Same Taxpayer Rule: The same taxpayer selling the relinquished property must purchase the replacement.
Deferring All Tax: The property the investor is purchasing must be equal or greater in value, equity and debt, but the debt can be replaced with cash.
Timing and Identification: The investor has 45 days from the closing of the relinquished property to identify the replacement property. The investor can only acquire property which has been properly identified during the 45-day identification period. If an investor wants to identify more than one replacement, there are several options: The Three Property Rule: The investor may identify up to three properties without regard to their fair market value; The 200% Rule: The investor may identify any number of properties so long as the total fair market value of all of the listed properties does not exceed 200% of the value of the relinquished property.
Once escrow closes on the relinquished property, the investor has the lesser of 180 days from the date of closing or the date on which the investor’s tax return for the year the relinquished property was sold is due, to close the purchase transaction and complete the exchange. For exchanges closing in the final quarter of the year, the taxpayer will need to get an extension to file his tax return to get the full 180 days.
I have completed a tax-deferred exchange for my own investment properties. We sold a four-unit apartment house and purchased a condominium. The condo needed deck repairs and the seller was going to credit us with $10,000 at close of escrow. I contacted the intermediary and was told that that $10,000 could be construed as “boot,” which is not allowed in an exchange. We arranged for a price reduction in that amount, so we were able to complete the exchange. One of my clients was asked to carry a 2nd trust deed on the relinquished property and was told by his accountant that the note could be considered boot as well. It is critical to keep in mind that the investor cannot receive any cash (boot) from the exchange.
Be sure to check with your tax advisor before entering into an exchange of investment property and I highly recommend that you use an intermediary.
