Section 1031 of the Internal Revenue Code allows the gain that otherwise would be taxed on the sale of a property to be deferred if the seller exchanges the property for a like-kind property. For a long time, the IRS took the position that the exchanges must be accomplished all at once. However, courts upheld non-contemporaneous, delayed exchanges where the exchange property was not yet identified at the time of the initial closing (a so- called “Starker” exchange). Congress supported this by amending Section 1031 of the Internal Revenue Code to permit delayed exchanges to take place within certain time periods. However, questions remained which made sellers reluctant to use the delayed exchange.
In a recent Revenue Ruling and new regulations, the IRS has provided answers to a few of these important questions. First, a 1990 Revenue Ruling permits the direct transfer from the owner of the replacement property to the taxpayer effecting the exchange. This eliminates the problem of the reluctance of the “middle man” in an exchange from accepting title, even if only briefly, because he does not want to be in the chain of title in the event there are environmental problems with the property.
The IRS’s new regulations set forth guidelines for identification of the replacement property in a delayed exchange and provide rules for identification of alternative properties. So that the seller may avoid a claim by that IRS that he had constructive receipt of the sale proceeds before the closing for the replacement property had taken place, the new regulations also provide safe harbor guidelines that permit the seller’s funds to be secured by a letter of credit, mortgage, or the guarantee of a third party or permit the seller to use a trustee to hold the funds and complete the transaction as the seller’s agent. The regulations also allow a seller to earn interest on the funds prior to the closing on the replacement property.
With these new regulations, a seller can feel more confident in structuring an exchange to assure deferral of his gain. In you have any questions about securing what could be substantial tax benefits as a result of delayed exchange, do not hesitate to telephone us.