A real estate owner who holds a property for investment or business purposes, sells the real estate and recognizes a gain. She pays the taxes on the gain at both the federal and state level and uses the remaining proceeds from the sale to purchase new real estate that will also be used for investment or business purposes. Soon, she realizes that in order to purchase new real estate with a value equal to the value of the sold real estate, she will need to dig deeper into her pockets (not her favorite activity) or borrow more money from the bank.
The owner then wonders if she can somehow preserve the value of the sold real estate and put all of the equity from it into the new real estate without taxes getting in the way. There is a transaction that can answer the owner’s query; a like-kind exchange.
A like-kind exchange allows the owner to sell real estate and then purchase new real estate without having to pay currently any taxes on the potential gain from the sale if specific requirements under the Code and Treasury Regulations are satisfied. In general, the potential taxes do not disappear; rather the taxes are deferred until the new real estate is sold.
In a typical like-kind exchange transaction, the owner signs a purchase and sale agreement to sell real estate that is used for investment or business purposes. Before the closing, the owner enters into an exchange agreement with an exchange facilitator who will act on behalf of the owner in the transaction. At the closing, the owner will deed the real estate to the buyer and the buyer will be directed to transfer the payment for the purchase price to the exchange facilitator. Within a stated period of time, the owner will designate the real estate that the owner wishes to purchase. And, within a stated period of time, the owner will purchase the new real estate that she will use for investment or business purposes. The purchase price will be paid (at least partially) from the funds held by the exchange facilitator.
The rules and requirements for the like-kind exchange transaction are numerous and must be followed exactly. Any deviation or failure to meet a requirement can jeopardize the tax benefits of the like-kind exchange transaction. These transactions can be complicated, so the planning should start as far ahead of the sale of the real estate as possible. With the appropriate planning, the like-kind exchange can allow the owner of real estate to purchase new real estate using all of the owner’s equity in the sold real estate without any diminution from taxes.