Tax Deferred Exchange

The advantage of using a tax-deferred exchange is to avoid part or all of the tax due on the gain in a real estate income or investment property. By avoiding the tax, the investor will have more funds to reinvest which should help accumulate their wealth position.
The example on the right would give the investor almost 18% more capital to reinvest.

It is always a good idea to get competent tax advice when attempting an exchange. The potential tax liability will usually justify the expense. Another professional to employ is a qualified intermediary who will be very valuable during the transaction.

There are several rules to consider in a like-kind exchange:

  • The replacement property must be equal to or greater in value than the property relinquished
  • The equity in the replacement property must be equal to or greater than the equity in the relinquished property
  • The replacement property must have equal or greater debt than the relinquished property
  • All net proceeds must be used in acquiring the replacement property
  • 45/180 Rule –
    • the taxpayer must identify the replacement property in a signed written document within 45 days of the sale (closing date) of the relinquished property
    • the replacement property must be closed within 180 days of the sale of the relinquished property
  • Non-qualifying property –
    • Property used for personal purposes such as principal residence, 2nd home
    • Dealer properties – such as a Fix ‘N’ Flip, inventory
    • Stocks, bonds, notes, and other securities
  • Boot is considered dissimilar property to that being exchanged. Cash, stocks, bonds, debt relief or other personal property would be considered boot when exchanging real estate
  • It is important that the taxpayer doing the exchange not receive, pledge, borrow or otherwise obtain the benefits of money or other property held by the qualified intermediary
  • For more information on this topic, see IRS Publication 544, Sales and Other Dispositions of Assets. Reporting of an exchange is done on IRS form 8824.

For advice considering your specific situation, contact your tax professional.

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