Readers of A Potpourri should by now be well aware that Section 1031 of the Internal Revenue Code permits the gain that would otherwise be taxed on the sale of a property to be deferred if the seller exchanges the property for like-kind property. Indeed, many of our clients regularly take advantage of Section 1031 to defer gains when selling real estate or other assets. In a “traditional” like-kind exchange, the seller finds a buyer for the seller’s property and simultaneously identifies the property the seller would like to acquire in the exchange. The buyer of seller’s property “acquires” the property seller has identified, and the buyer and seller then exchange the two properties. Each ends up with the property they wanted, and seller is permitted to defer the gain on the property seller relinquished.
Frequently, however, the seller finds the replacement property before it has found a buyer for the property it will relinquish. Sometimes this occurs because the seller is building a new facility for its business, but cannot move out of its existing facility until the new facility is completed. Whether seller would be able to effect an exchange of the existing building for the new building has always been a question. In attempting to qualify transactions as reverse like-kind exchanges, taxpayers would “park” the replacement property with a third party until the taxpayer was ready to complete the exchange. Recently, the Internal Revenue Service issued proposed regulations that will permit these “reverse” like-kind exchanges.
The new rules provide the IRS will not challenge the qualification of a property as a replacement property, or as a relinquished property, if the “safe harbor” procedures are followed. The rules set forth nine requirements that must be followed; the requirements are no more complicated than the current regulations for delayed, or “Starker,” exchanges. The requirements include: the replacement property must be owned by an independent party (the exchange accommodation titleholder or “EAT”) that is a U.S. taxpayer; the exchange must be pursuant to a written agreement; there must be a bona fide intent to accomplish a 1031 exchange; the relinquished property must be properly identified; and the transaction must be completed within certain time periods, which are similar to the time periods for Starker exchanges. The structuring of such transactions is relatively simple and need not be expensive. Many financial institutions and title insurance companies will act as qualified intermediaries for a reasonable fee. Keep in mind that a Section 1031 deferral is not just for real estate – the gains on machinery, equipment and other types of personal property may be deferred if they are exchanged for like-kind property.
If you have any questions regarding the application and advantages of Section 1031, including the new “reverse” exchange safe harbor provisions, please do not hesitate to telephone us.