Planning Makes Like-Kind Exchanges Work

Like-kind real estate exchanges are a legal shell game that can help property owners defer big bucks in tax liabilities. They’re also complicated maneuvers that are best made and explained by pros like Christopher T. Rogers.

A tax lawyer with Mitchell, Williams, Selig, Gates & Woodyard PLLC in Bentonville, Rogers formerly served as an attorney advisor for the Internal Revenue Service Chief Counsel’s office in Washington, D.C. He actually helped write IRS Code 1031, which enables property owners to defer tax liability on capital gains from certain real estate transactions.

Since 1990, when he joined the firm’s Little Rock office, Rogers has done hundreds of like-kind exchanges for Arkansas property owners. He relocated to the Bentonville office in 1993.

“It’s not right for everyone,” Rogers said. “You need some planning up front and it’s best to contact your C.P.A., financial planner or attorney before you even enter into a sales contract. But it can be very beneficial, and if done properly will defer the liability on your gain.”

The transaction typically involves people who bought property for a low investment, and held it for a number of years. Then they received a much higher offer to sell the property, causing them to incur a large capital gain. IRS Code 1031 basically allows the owner to reinvest that money in other property or properties instead of taking the tax hit.

A simple and common local example is a farmer who, for instance, bought some pasture land years ago for $50,000. A commercial developer comes along and wants to buy it now for $200,000. So the farmer faces a capital gain of $150,000 and the resulting taxes.

Capitol gains taxes run from 10 to 25 percent.

But the like-kind provision would enable the farmer to use his profit to buy qualifying new property. There are, however, some restrictions.

“It has to be property that the taxpayer has held for use in a trade or business, or that was used as an investment,” Rogers said. “That generally will encompass everything other than assets held for personal use. Residences and second homes generally don’t count, although a vacation home might if the owner used it fewer than 14 days per year.”

A qualified intermediary, which locally is often a title company, will hold the gain until a replacement property can be found. The money is typically invested in a money market account to earn interest.

According to the code, once an exchange agreement is begun the tax payer “does not have the right to receive, pledge or borrow the proceeds of the transfer of the relinquished property, except for the purchase of qualifying replacement property.” At the completion of the exchange, if all of the gain was reinvested then all of the tax liability is deferred.

If there’s a net, say if the same farmer only bought $100,000 worth of new property, he’d face a gain of $50,000 and the appropriate capital taxes.

Property owners have 45 days from the close of their relinquished property to identify possible replacements. There’s also a 180-day period after close that the owner may use to actually purchase new property. Rogers said the 45-day period can expire quickly if the taxpayer hasn’t done some homework in advance.

Another common problem is the taxpayer has property for sale and finds a replacement investment before being able to close on the old property. The IRS only recently established guidelines for a “reverse like-kind exchange” to deal with that situation.

There are many other wrinkles, too. But both Rogers and Linda Winters, the closing agent for Tucker Abstract & Title Inc. in Bentonville, said the most important thing to do is hire a pro to help with the process.

“Just be real clear about what you’re doing and realize that you get what you pay for,” Winters said. “We’ve heard of some bargain deals that have really made us worry. Just plan ahead and hire a pro.”