While the real estate market continues to boom and properties keep switching hands, more and more investors are looking for a way to reduce or eliminate their tax burdens. Under the new law (Tax Cuts and Jobs Act or TCJA), like-kind exchanges of commercial and investment real estate properties remain untouched and exempt from tax. However, things usually aren’t so cut-and-dried in the real world. For example, it’s unlikely the potential buyer of your property will own any real estate that you desire. What to do? Use a “qualified intermediary” to facilitate the deal. The intermediary can be inserted in the middle of a multiple-party exchange. In the end, you wind up with the property you want.
Like-kind exchanges involving multiple parties are often called “Starker exchanges” after the landmark case approving their use. (Starker, 602 F2nd 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 it is in a large nutshell: The tax law definition of like-kind real estate 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 (cash, or reduced mortgage liability of property that is not like-kind). But there are TIME RESTRICTIONS:
- The property that you will receive in the exchange 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 (including any extensions of the due date).
Fortunately, the qualified intermediary can help you overcome these timing hurdles. For 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 exchange. Simple right? 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. Keep in mind and factor this into your decision, that Qualified intermediaries generally charge fees based on the value of the properties. You didn’t think all this was free, did you? However, it would cost you a lot more if you did not handle the transaction properly. Herein is the end of the lesson.