Types Of Tax Exchanges

Types Of Tax Exchanges
Although the​ vast majority of​ exchanges occurring presently are delayed exchanges,​ let us briefly explain a​ few other exchanging alternatives.
Simultaneous Exchange
As mentioned previously,​ prior to​ Congress modifying the​ Internal Revenue Code as​ to​ exchanges and formally approving the​ concept of​ delayed exchanging,​ virtually all exchanges were of​ the​ simultaneous type .​
To qualify as​ a​ simultaneous exchange,​ both the​ relinquished property and the​ replacement property must close and record on​ the​ same day.
Some investors still try to​ accomplish simultaneous exchanges,​ primarily to​ avoid or​ reduce the​ payment of​ multiple closing fees or​ exchange fees to​ a​ facilitator .​
There is​ significant danger and legal exposure in​ this attempt since many unforeseen events can cause the​ closing to​ be delayed on​ one of​ the​ properties,​ leaving the​ investor with a​ failed exchange and the​ obligation of​ taxes that would otherwise be deferred.
For example,​ if​ the​ properties are located in​ different counties,​ it​ is​ highly unlikely that the​ closing can take place on​ the​ same day .​
If two different title,​ escrow,​ closing firms or​ attorneys are involved,​ it​ is​ virtually impossible for both to​ have the​ funds to​ close in​ their possession on​ the​ same day .​
For instance,​ with Good Funds laws existing in​ many states,​ an​ escrow holder cannot disburse funds not actually in​ his possession .​
Further,​ in​ directing an​ escrow holder to​ disburse funds for the​ purchase of​ the​ replacement property,​ it​ could be contended by the​ IRS that the​ investor had what is​ considered constructive receipt of​ the​ proceeds of​ the​ sale,​ and therefore taxes on​ the​ gain would be due.
However,​ the​ 1031 regulations contain what is​ referred to​ as​ a​ Safe Harbor provision,​ which does provide that in​ the​ event a​ facilitator or​ intermediary is​ used in​ a​ simultaneous exchange,​ and the​ transaction proves not to​ be simultaneous,​ the​ exchange will not fail simply for that reason.
Improvement and Construction Exchange
In some cases,​ the​ replacement property requires new construction or​ significant improvements to​ be completed in​ order to​ make it​ viable for the​ specific purpose the​ Exchangor has intended for the​ property .​
Such construction or​ improvements can be accomplished as​ part of​ the​ exchange process,​ with payments to​ contractors and other suppliers being made by the​ facilitator out of​ funds held in​ a​ trust account .​
Therefore,​ if​ the​ replacement property is​ of​ lesser value than the​ relinquished property at​ the​ time of​ the​ original transaction,​ the​ improvement or​ construction costs can bring the​ value of​ the​ replacement property up to​ an​ exchange level or​ value which would allow the​ transaction to​ remain tax free.
Business or​ Personal Property Exchange
Although our discussion in​ this tutorial involves the​ typical exchange of​ real property,​ Internal Revenue Code Section 1031 does allow the​ exchange of​ many types of​ property other than real estate .​
Investors may exchange,​ for example,​ rail cars,​ trucks,​ ships,​ classic cars or​ livestock,​ among other assets .​
Therefore,​ business exchanges are a​ common transaction.
While the​ basic exchange rules are the​ same,​ certain complications arise in​ classifying the​ non-real estate assets into one of​ several categories or​ SIC classes so that they meet the​ associated like-kind requirements.
While this is​ a​ simple enough process for the​ experienced facilitator,​ it​ can be thoroughly confusing for the​ uninitiated Exchangor,​ making the​ selection of​ his Intermediary or​ facilitator extremely important to​ the​ successful structuring of​ the​ exchange.
If you​ desire additional information regarding business or​ personal property exchanges,​ please consult an​ experienced tax professional to​ first determine the​ classes of​ properties available to​ be exchanged .​
Then,​ remembering that all personal property must be exchanged within the​ same class (locomotive for locomotive,​ collectible art for collectible art,​ pizza oven for pizza oven,​ etc.),​ assign values for the​ various assets within that class .​
These collective values,​ will then reflect the​ value of​ the​ total exchange.
Also,​ some personal property and business items are not exchangeable .​
Most notable in​ this group are such items as​ goodwill or​ inventory.
Again,​ as​ mentioned above,​ do not undertake the​ planning of​ a​ business or​ personal property exchange without the​ assistance of​ an​ experienced tax professional .​
In any business exchange,​ the​ time and money you​ invest in​ planning will be well worth it​ when your transaction is​ deemed qualified.
Reverse Exchange
The reverse exchange is​ actually a​ misnomer .​
It represents an​ exchange in​ which the​ Exchangor locates a​ replacement property and wants to​ acquire it​ before the​ actual closing of​ the​ relinquished or​ exchange property .​
Since the​ Exchangor cannot purchase the​ replacement and later exchange into property that he already owns,​ he must find a​ method to​ acquire the​ replacement property and still maintain the​ integrity of​ his exchange .​
Reverses are typically accomplished in​ two formats based upon transaction logistics and the​ financing needs of​ the​ Exchangor.
The Scenario a​ strategy is​ utilized only when the​ Exchangor requires traditional financing to​ complete his acquisition of​ the​ replacement property .​
Since few lenders would lend dollars to​ the​ Exchangor with the​ facilitator on​ title,​ it​ is​ necessary for the​ facilitator to​ warehouse or​ hold the​ title to​ the​ relinquished property .​
In this approach,​ the​ exchange is​ complete at​ the​ moment the​ Exchangor accepts the​ title to​ the​ new replacement property .​
However,​ with the​ prospect of​ the​ exchange being complete,​ it​ is​ necessary to​ balance equities between relinquished and replacement,​ prior to​ closing .​
In other words,​ upon closing the​ replacement,​ there must be an​ equal amount of​ equity in​ the​ replacement property as​ is​ expected to​ come out of​ the​ later sale of​ the​ relinquished property .​
Then,​ at​ the​ time of​ the​ later sale of​ the​ relinquished or​ exchange property,​ any debt is​ retired and the​ Exchangor is​ repaid any dollars which he advanced for the​ replacement property acquisition.
In Scenario A,​ the​ facilitator,​ with the​ aid of​ a​ loan from the​ Exchangor,​ acquires the​ replacement property and warehouses or​ holds the​ property title until such time as​ the​ relinquished property is​ sold and the​ exchange can be completed.
At this point we need to​ insert several caveats regarding reverse exchanges .​
They tend to​ be more complicated than other exchanges and because they involve the​ holding of​ title by a​ facilitator,​ they require extensive planning .​
Also,​ since the​ reverse exchange strategy was specifically excepted from the​ Treasury Regulations,​ they should be considered an​ aggressive form of​ exchanging .​
Do not undertake a​ reverse exchange without the​ assistance of​ an​ experienced and knowledgeable facilitator or​ Intermediary.
Delayed Exchange
Generally,​ when one discusses exchanges,​ the​ type of​ exchange referred to​ is​ the​ delayed or​ Starker exchange .​
This term comes from the​ name of​ the​ Exchangor who was first challenged for a​ delayed exchange by the​ IRS .​
From this tax court conflict came the​ code change in​ 1984 that formally recognized the​ delayed exchange for the​ first time .​
As mentioned earlier,​ this is​ now the​ most common type of​ exchange.
In a​ delayed exchange,​ the​ relinquished property is​ sold at​ Time 1,​ and after a​ delay,​ the​ replacement property is​ acquired at​ Time 2 .​
The following will represent the​ traditional rules and time constraints for completing a​ qualifying delayed exchange.
Like-Kind Property
Property that qualifies for exchange under Section 1031 must be like-kind,​ which is​ defined in​ the​ Regulations as​ follows:
a) Property held for productive use in​ a​ trade or​ business,​ such as​ income property,​ or
b) Property held for investment.
Therefore,​ not only is​ rental or​ other income property qualified,​ so is​ unimproved property which has been held as​ an​ investment .​
That unimproved property can be exchanged for improved property of​ any type,​ or​ vice versa .​
Also,​ one property may be exchanged for several,​ or​ vice versa .​
This means that almost any property that is​ not a​ personal residence or​ second home is​ eligible for exchange under Section 1031 .​
Even the​ vacation home that is​ used for that purpose part of​ the​ year,​ and is​ rented part of​ the​ year,​ is​ considered mixed use property and may be exchanged under 1031 for other mixed use property.
Types Of Tax Exchanges Types Of Tax Exchanges Reviewed by Henda Yesti on July 05, 2018 Rating: 5

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