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Following the rules, of course, is important

Like-kind exchanges can lead to tax savings

Want to save a great deal of money on capital gains taxes from the sale of investment properties? You would do well to look at like-kind exchanges of commercial real estate allowed under the Internal Revenue Code 1031 tax deferred exchange.

“Anyone can sell investment property, put the money in a checking account, and reinvest in additional investment property down the road,” said Mike Engle, regional sales manager for the Old Republic Exchange Facilitator Company in Madison, which specializes in handling 1031 IRS exchanges. “But when done properly, exchange of a like-kind investment property is not a taxable sale. By following the rules, you are able to defer taxes on that property until it is eventually sold. It is a great way to save a ton of money on capital gain taxes.”

While sales of personal homes are exempt from capital gains taxes, the same is not true for rental homes, apartment buildings and other types of commercial properties.

Reasons for considering the like-kind exchange vary. People might have a great opportunity to sell a commercial property, but be wary because of the tax liability. Someone may also want to diversify risk by trading a $300,000 building for three $100,000 buildings. Another reason for considering an exchange is if you are moving and don`t want to be tied down by management responsibilities.

“Checking accounts and stock certificates are portable,” Engle said. “But land isn`t. If you are relocating from North Carolina to Mississippi, you might not want to keep up property in North Carolina. So you could sell that property and, by utilizing an exchange, you could buy another piece of property of equal or higher value in Mississippi and not have to pay any capital gains tax on profits from the sale,” Engle said.

Investors can`t just go through their attorney to handle the transaction. The IRS requires that a “qualified intermediary” be used to properly structure the deal.

Engle said the first and last concern in the exchange transaction should be security and integrity. Making sure your funds are secure and that your transaction be processed accurately are the two most important considerations.

“Unfortunately, there is no federal regulation of the qualified intermediary industry,” said Engle, who gives continuing education credit classes for real estate agents and attorneys on the 1031 exchange. “And, because it is fairly easy to become a qualified intermediary, it is imperative that you place your exchange funds with a qualified intermediary who can protect your assets. You must ask the following three questions: First, will the qualified intermediary provide a written guarantee of the exchange proceeds? Second, is the qualified intermediary adequately insured? Finally, what is the financial strength of the qualified intermediary and its affiliated companies?”

Engle said the qualified intermediary does the following:

• Consults with your tax advisor to assure your transaction is properly structured to qualify for tax- deferred status.

• Prepares the legal documents necessary to facilitate your transaction, including the exchange agreement, the assignment, the exchange contract addendum and the exchange account closing summary.

• Executes closing documents and, where necessary, reviews and executes financing documents.

• Acts as the principal, by way of an assignment, in your purchase and sale transactions.

• Holds your exchange proceeds so that you do not have actual or constructive receipt of the funds.

• Coordinates with your real estate agent, tax advisor and/or attorney, escrow/closing officer and lender to ensure the smooth and accurate processing of your exchange transaction.

The bottom line is that with a like-kind exchange, you can save hundreds of thousands in taxes that can be used to reinvest in more property, rather than going to the IRS.

Engle said that “like kind” is not always understood. Like kind means similar in nature and character notwithstanding differences in grade or quality. Any type of commercial property can be exchanged as long as the property purchased is for productive trade, for a business or held as an investment.

“Raw land held for investment may be exchanged for single-family rentals used for a trade or business or any combination of the following: single family rentals, farms/ranches, office/commercial, motels\hotels, golf courses, some recreational properties, multi-family rentals, raw law, retail, industrial and leasehold interests of 30 years or more,” Engle said.

The like-kind exchanges are becoming increasingly popular in Mississippi, as well as across the country.

“We are doing more and more,” Engle said. “We now average several per week. I’m working hard to educate Realtors and attorneys about the opportunities they need to trigger when clients discuss selling any property other than homes. This is just a no-brainer way to go. My biggest struggle is trying to educate people about this to let us get involved before they close.”

Old Republic Exchange also does what is known as a reverse 1031 sale. In that case people first find the property they want to buy before selling the property they want to use for the exchange. With the reserve exchange, the qualified intermediary will take title and give you 180 days to sell your property. After the property sells, the intermediary sells the property to the client using the 1031 exchange services.

Engle advises people to be very careful about the details of the like-kind exchange. For example, there are no extensions to the 45-day requirement for the exchange. If you don`t find something to exchange for the original property by the 45th day, the intermediary returns the sale proceeds and an exchange is no longer possible.

“The rules are extremely picky, and very intricate,” Engle said. “A lot doesn`t make sense such as not allowing any extensions. Those are the rules and they hold you to them. But if you do this properly, it is one of the last great tax loopholes out there.”

Things to consider when choosing a qualified intermediary include the company`s track record at preparing documents quickly, attorneys available to answer questions, and fees charged for the service.

Contact MBJ contributing writer Becky Gillette at bgillette@bellsouth.net.

About Becky Gillette

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