Despite like-kind exchanges of commercial or investment real estate properties being exempt from tax, the process sometimes can be a little intimidating until you understand the mechanics. For instance, it is highly unlikely that the buyer of your property will own any real estate you wish to acquire and most often merely wishes to purchase your real estate. What do you do then? Easy, use a “qualified intermediary” to facilitate the deal to ensure that you end up with the property you want without paying capital gains tax on the sale of your old property.
Fortunately, the definition of like-kind real estate is a relatively liberal one that refers to the nature of the property, not its quality or grade i.e. warehouses, apartment building and raw land can all qualify for this tax-free treatment (personal property, your primary residence and property held primarily for resale are examples of what does not qualify for this favorable tax treatment). The only tax that would be owed under a properly executed like-kind exchange is if you receive any “boot” as part of the deal i.e. cash or a reduced mortgage liability.
However, two key time restrictions must be followed: first, the replacement property you receive in the exchange must be identified within 45 days of transferring your property; and second, the replacement property must be received within the earlier of 180 days after the transfer your property or the due date of the tax return for that year (including any extensions of the due date).
So where does the qualified intermediary come into play? When you use one, you actually will have four separate parties to the deal: (i) you; (ii) the qualified intermediary; (iii) the purchaser of your property; and (iv) the seller of the replacement property you wish to obtain. The first step is to sell your property to a buyer who in turn deposits the cash proceeds with the qualified intermediary. The qualified intermediary holds the cash until you identify the replacement property you wish to obtain. Once you do, the qualified intermediary purchases the replacement property from its owner using the cash from the sale of your real estate and then transfers ownership of the replacement property to you.
Since you never received the cash from the proceeds of the sale of your property, for tax purposes you are considered to have swapped the properties tax free with the help of the qualified intermediary.
However, to qualify for this tax-free treatment, you and the qualified intermediary must execute a “Qualified Exchange Accommodation Agreement” in which the intermediary agrees to hold the property to enable the tax-free exchange in accordance with the IRS reporting requirements in exchange for a fee (typically based on the value of the properties exchanged).
If you would like to sell your commercial or investment real estate and buy new property without having to pay capital gains tax, contact our office to discuss how we can help you swap your real estate tax free.