• 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

    like-kind exchange:

    Property

    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.

    Purpose

    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.

    Like-Kind

    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.

    Exchange

    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

    exchanger’s benefit.

    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

    relinquished.

    Safe Harbors

    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.

     

    2004 Duluthian, reproduced with permission