- Consider the Legal Structure When Selling Commercial Real Estate
- March 29, 2010 | Author: Alok Vidyarthi
- Law Firm: Johnson, Killen & Seiler A Professional Association - Duluth Office
Owners of appreciated commercial real estate may be able to defer
payment of capital gains taxes by using a like-kind (tax-deferred)
exchange, rather than a sale. The concept behind a like-kind exchange
is that property owners exchange similar commercial properties, as
opposed to selling and buying them,and receive a capital-gains tax
deferral, presumably because the Internal Revenue Service is trying to
encourage like-kind exchanges as an investment vehicle. There are some
requirements to meet the conditions to qualify for the status as a valid
Generally, all types of property, real and personal, qualify for a like-kind
exchange and tax-deferred treatment. However, there are certain types of
property that don’t qualify, such as interests in partnerships.
Property can be considered for a likekind exchange if it’s been owned and
used in a trade or business or for investment. The same must be true
for the property that’s being acquired.
The properties subject to a like-kind exchange must also be similar in
nature and characteristics. For example, real property is like-kind to
other real property, but real property is not like-kind to personal property.
The relinquished property and the replacement property must be
exchanged with each other, as opposed to the relinquished property being
sold and the replacement property being purchased. To distinguish a like-
kind exchange transaction from a sale and purchase transaction, certain
“qualified” intermediaries must be used (e.g., a title company), primarily
to hold transaction proceeds and possibly the title to property for the
Forward and Reverse Exchanges
There are two different situations in which like-kind exchanges occur —
forward and reverse. While forward exchanges have been in existence for
years, reverse exchanges are relatively new and expand the opportunity for
commercial property capital-gains taxes to be deferred.
A forward exchange is one in which certain qualifying property is sold
and the cash proceeds are held by the qualified intermediary until such
time as the cash proceeds are used to purchase a qualifying piece of
replacement property. A reverse exchange is one in which qualifying
replacement property is purchased and the title held by a qualified
intermediary until such time as a similar property for sale is later
There are certain compliance requirements called safe harbors. In
like-kind property exchanges, these safe harbors may provide some
protection from Internal Revenue Service challenges. These safe
harbors apply to deferred exchanges for the most part. In a forward
exchange, the person making the exchange of property must identify the
replacement property within 45 days of the closing on the relinquished
property, and then must close on the replacement property within 180 days
after the the closing on the property that’s being given up. In a reverse
exchange, the person exchanging properties must identify the
relinquished property within 45 days of the closing on the replacement
property and then must close on that property within 180 days.
If the compliance requirements of the safe harbors are not satisfied, that
doesn’t necessarily mean that the IRS will challenge the transaction, but
the level of risk to the person making the exchange is heightened.
Alok Vidyarthi is a partner with
Johnson, Killen & Seiler, Attorneys.