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With stepped up commercial activity taking place in
Evansville, more clients may be considering selling
business or investment real estate. Frequently clients
hold onto property because they don't want to recognize
the capital gain, overlooking an easy opportunity to defer
taxes. Exchanging like kind property under Internal
Revenue Code section 1031 may put off recognizing taxable
gain.
The beauty of these exchanges is that they defer the
payment of tax, allowing sellers to use the dollars that
would have gone to Uncle Sam to buy more. Usually they are
selling land or land and a building. With the proceeds,
they can make another investment. If that investment is in
another piece of real estate, they can defer tax.
Sometimes that deferral can even be permanent. The
exchange does not have to be for identical types of real
estate. For example, a farm can be sold and replaced with
other real estate, such as an apartment building, office
building or "strip-mall" shopping center.
To achieve deferral of taxes under section 1031, three
basic rules must be observed meticulously:
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The transaction must be structured as an exchange, not as
a sale and re-purchase.
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Property must be like-kind.This is easy for real estate,
but exchanges can apply to tangible personal property as
well and the definitions are more difficult for personal
property under the tax code.
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Property bought and sold must be used in trade or business
or for investment purposes. Property held for sale, such
as an inventory of homes in a subdivision, don't qualify.
Purchases and sales don't have to take place
simultaneously. The mechanics of a non-simultaneous
transaction, which requires funds to be held by a
qualifying intermediary, must be handled with great care
to come within the technical rules of the tax regulations.
Within 45 days after the sale, a replacement parcel has to
be identified and then acquired within 180 days. By
careful adherence to the rules, the rewards of tax
deferral can be enormous.
The rules permit a great deal of flexibility if advance
planning is done. For example, clients may convert one
parcel of real property into several different types of
replacement property (apartments, farm land, shopping
centers and office buildings), increase income, finance to
leverage broader ownership, improve quality, diversify
geographic ownership or whatever the needs may be.
However, careful planning usually needs to take place
before entering into a sales contract.
Like-kind exchanges are cost-effective for clients whose
tax savings will exceed $6,000-$10,000. To have this level
of tax savings, the capital gain on the sale property need
only be $21,000 to $35,000. In a like-kind exchange, the
taxpayer incurs additional transaction fees and additional
intermediary fees which negate the benefit of tax deferral
if the capital gain is less than $21,000.
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