Avoiding Taxes on Real Estate Transactions Through Like-Kind Exchanges
Kevin D. Fontana, CPA, MSA
With most of the country experiencing a depressed real estate market, you may find it difficult to sell a business building or apartment building. To make matters worse, a sale could result in significant tax consequences for real estate property that has appreciated in value since it was acquired.
Fortunately, there is a way to avoid dire tax problems. Assuming that a suitable replacement property can be identified, an exchange of properties can be arranged. If the properties are considered “like-kind” the person generally does not have to pay current tax on the exchange.
The basic premise is this: the rules for like-kind exchanges apply to investment or commercial property (they cannot be used for residential homes). This refers to the nature, character or class of the property – not its grade or quality. For example, a swap of an office building for an apartment building of the same value can qualify as a like-kind exchange. As a result, neither party has to report taxable income.
Although other types of property may qualify under the rules, the majority of these transactions involve real estate. However, in the real world, trading real estate properties is usually not so simple.
Suppose someone wants to acquire real estate, but the owner is not interested in any of the properties that you own. The tax law allows the would-be buyer to take the like-kind exchange concept one step further. The exchange can involve multiple parties if the two owners cannot agree on the properties to be swapped.
Here is an example: Tinker wants to acquire property owned by Evers. However, Tinker does not own any property that Evers desires in return. After discussing a number of locations, the two of them strike a deal with Chance. Evers agrees to take Chance’s property, Chance acquires title to a property owned by Tinker, and Tinker obtains the property he wanted all along.
The IRS has approved the use of a qualified intermediary to facilitate the deal, as long as the intermediary is not connected with one of the other parties. Also, be aware that time restrictions are involved in a multiple-party swap. In general, the property must be identified within 45 days of the original transfer, and title must be taken within 180 days (or the tax return due date plus any extensions, if that is sooner).
Assuming like-kind properties are involved, the entire transaction may be tax-free if the deal is completed within these time frames. However, there is one catch: if any money or property received as part of the deal, the additional amount – called “boot” – is subject to income tax. On the other hand, no loss is recognized by the taxpayer who provides the boot. The assumption of a greater mortgage is also treated as taxable boot for this purpose.
Finally, people should be forewarned that, while completely above board, the IRS is often skeptical of these transactions. This is a complex area of the tax law, so professional assistance is a must.
Kevin D. Fontana, CPA, MSA, is a tax manager at BlumShapiro, the largest regional accounting, tax and business consulting firm based in New England, with offices in Connecticut and Massachusetts. The firm, with nearly 300 professionals and staff, offers a diversity of services which includes auditing, accounting, tax and business advisory services. In addition, BlumShapiro provides a variety of specialized consulting services such as succession and estate planning, business technology services, employee benefit plans, litigation support and valuation, and financial staffing. The firm, with offices in West Hartford and Shelton, CT and Boston and Rockland, MA, serves a wide range of privately held companies, government and non-profit organizations and provides non-audit services for publicly traded companies.