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Thinking about a real estate swap? Use a go-between

by on
in Small Business Tax,Small Business Tax Deduction Strategies

Instead of making an outright sale of commercial or investment property, the tax law enables you to “swap” it for like-kind property without paying any current tax. However, things aren’t usually so cut-and-dried in the real world. For one thing, it’s unlikely the potential buyer of your property will own any real estate you desire.

Strategy: Use a “qualified intermediary” to facilitate deals. The intermediary can be inserted in the middle of a multiple-party exchange. In the end, you wind up with a property you want.    

Like-kind exchanges involving multiple parties are often called “Starker exchanges” after the landmark case approving their use. (Starker, 602 F2d 1341, 9th Cir., 1979) As long as you meet the tax law rules and deadlines for a Starker exchange, you can swap property tax-free.

Here’s the whole story: The tax law definition of like-kind property is a relatively liberal one. It refers to the nature of the property, not its quality or grade. For example, you can swap a warehouse tax-free for an apartment building or even raw land. You owe tax only to the extent you receive any “boot” as part of the deal (e.g., cash or reduced mortgage liability or property that is not like-kind).

But, there are two key time restrictions:

  1. The property that you will receive in the exchange must be identified within 45 days of transferring the property.
  2. The property must be received within the earlier of 180 days after the transfer or the due date of the tax return for that year (including any extensions of the due date).   

Fortunately, a qualified intermediary can help you overcome these timing hurdles.  

Example: You use a qualified intermediary for a Starker exchange involving four parties. Technically, you (the first party) sell the property you’re relinquishing to a cash buyer (the second party). But the cash buyer pays the intermediary (the third party) instead of you. The intermediary holds the proceeds until you identify a suitable replacement property.

At that point, the intermediary uses the sales proceeds to buy the replacement property from its owner (the fourth party). Finally, the intermediary transfers this property to you to complete the like-kind exchange.

For tax purposes, you’re considered to have swapped properties tax-free with the intermediary. That’s because no cash actually exchanges hands (except to the extent cash boot is involved). The intermediary handles the funds on your behalf.

To qualify for tax-free treatment, you and the qualified intermediary must sign a “Qualified Exchange Accommodation Agreement.” The agreement should state that the intermediary is holding the property to facilitate a tax-free exchange. The intermediary must also agree to meet all the technical reporting requirements spelled out by the IRS.

Tip: Qualified intermediaries generally charge fees based on the value of the properties.

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