Park property in like-kind exchange

Pulling off a like-kind exchange under Section 1031 is often easier said than done. Usually, the owner of property you have your eyes on isn’t interested in any property you own.  

Strategy: Add a “qualified intermediary” to the mix. An intermediary can be inserted in the middle of a deferred exchange so you can “park” the money from selling the first property until you find the replacement property. In the end, everyone winds up with the property they want.

But to further complicate matters, like-kind exchanges could be affected by tax reform. This tax break is squarely in the crosshairs of legislators, with the GOP-led House and President Trump supporting changes that would effectively eliminate the main tax benefits. Suffice it to say, if you want to make a like-kind exchange, it might be better to get it done sooner rather than later.  

Here’s the whole story: The current tax rules under Section 1031 and its regulations are relatively liberal. For example, you can exchange 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 non-like-kind property or a reduced mortgage liability). In other words, any tax that would be due based on the appreciation in value of your property is deferred until you sell the replacement property—if ever.  

However, there are two key timing requirements for tax deferral:  

1. The replacement property received in the exchange must be identified within 45 days of transferring the relinquished property.

2. The replacement property must be received by the earlier of 180 days after the transfer of the relinquished property or the due date of the tax return for that year (including any extensions).

As we said earlier, it is really unusual to arrange a swap between just two parties. Like-kind exchanges that involve multiple parties are often called deferred exchanges or “Starker exchanges,” after the landmark case approving their use. (Starker, 602 F2d 1341, CA-9, 1979) As long as you meet the tax law deadlines, you can still avoid tax with a Starker exchange.

Frequently, a qualified intermediary can help you overcome the obstacles.

Example: You use a qualified intermediary for a Starker exchange involving four parties. You (Party A) sell the property you’re relinquishing to a cash buyer (Party B). But the cash buyer pays the intermediary (Party C) instead of you. The intermediary temporarily holds the proceeds until you identify a suitable replacement property.  

Eventually, the intermediary uses the sales proceeds to buy the replacement property from its owner (Party D). Then the intermediary transfers this property to you (Party A) 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 funds on your behalf.

Tip: A qualified intermediary will generally charge a fee based on the value of the properties.