In a recent article, we discussed exchanging real estate properties tax-free under Section 1031 of the tax code. However, in the real world, it’s unlikely that the owner of the property you desire will be willing to acquire a property you own, or vice versa.
Strategy: Use a qualified intermediary to facilitate deals. The intermediary can be inserted in the middle of a multiple-party exchange. End result: Everyone winds up with a property they 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 deadlines for a Starker exchange, you can still swap property tax-free.
Here’s the whole story: The tax rules under Section 1031 are relatively liberal. 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). However, there are two key time restrictions:
- The property being exchanged must be identified within 45 days of transferring the property.
- 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 (plus any extensions).
Fortunately, a qualified intermediary can help you overcome these timing obstacles.
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 (the first party) 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. The intermediary handles the funds on your behalf.
Tip: To qualify for tax-free treatment, you and the qualified intermediary must each sign a “Qualified Exchange Accommodation Agreement.”