Reverse Like Kind Exchange

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Keeping on the subject of like kind exchanges.
ody Burden found a great deal on an office building. But he needed to sell the office building he owned, but didn’t want to lose the new office building. Bidding was hot and heavy, so he knew if he had a long settlement date he’s lose the office building. He went to his lawyer to ask what he should do. The lawyer replied, “How about a reverse like kind exchange. In that situation, you get a bridge loan from a bank and buy the other property and park the old property with a qualified intermediary. So long as they report the transaction on their taxes, its great.”

The lawyer called Sundasky Intermediary Company and they set up a Corporation to handle the transaction. After procuring the bridge loan which was secured by both old and new property, the old property was deeded to Sundasky Old Property Corporation and at that time Jody identified New Property to Sundasky. The new property was acquired by Jody, the same day. Within 180 days, Old Property was sold to Perry Prospector and the loan was partially paid off from the proceeds and Old Property was released from the Mortgage. No money went to Jody. Jody and Sundasky Old Property Corporation filed and reported the transaction on their tax returns. No income tax was payable.

Success, sort of!

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Cedric settled on the property, the money went to the qualified intermediary and 45 days later he found a great piece of vacant land to invest in. He settled pretty quickly, the intermediary wiring the money smoothly, and he deferred the taxes until he sells this land. He was thrilled. Feeling rich, he went by the Biker’s shop and bought a new Crotch Rocket. Two days later, he died in a a motorcycle accident. His family got to step up his basis in the property (as is allowed after a loved one dies) to the date of death value, and they quickly sold the land and paid no income taxes on the transaction.

The Plan

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“Hi, I’m Cedric”. “I’m Ito Brassballs, what can I do for you?” “I’ve got this condo that I’m selling and I’m supposed to make about $475,000 in gains, and I heard that there’s something called a like kind exchange that can save me some taxes”, Cedric said matter of factly. “Is it an investment property?” the lawyer queried. “Yes”, Cedric answered. “Then, yes you can do an exchange for other real property. There are two types of like kind exchanges. A direct exchange which happens rarely these days because it so hard to match two people to swap property. The other is a deferred exchange in which you settle on the property, the money is placed in the hands of an intermediary and held in an escrow account. You have 45 days to identify replacement property and 180 days to settle on it, under the safe harbor under the regs”, Ito answered. “So let me get this straight, I settle on the property, go out and find new property, identify it to the Intermediary in 45 days, settle on it in 180 days?” Cedric repeated. “Yes”, there are a few other rules. The replacement property must not be purchased for personal use. You have to take on as much debt as you had on your previous property or recognize gain. In essence the purchase price has to exceed the purchase price of the property you’re surrendering”, as a rough rule of thumb. Also, if you get any cash you’ll owe tax on it. Your basis will only change slightly so you ae deferring the taxes not saving them. I can prepare an addendum to your sales contract”, Ito replied. “That would be great “ Cedric replied. After Ito told him all the fees involved, he prepared the addendum to the real estate sales contract.

I’ll trade you a condo for a farm

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We are now embarking on a short tale about the concept of like kind exchanges. The Tax Code permits the tax free exchange of property of like kind so long as no cash or non-like kind property changes hands. We will start with the easy tale of the pure unvarnished like kind exchange and move to tales involving more complex portions of the law.
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Cedric bought a condo for rental in 1990 for $200,000. As required by law, he took depreciation (whether he wanted to or not) from 1990-2009 in the amount of $125,000. In 2009, out of the blue he was offered $500,000 for the condo. He consulted his accountant, Frank Dinero.

“Cedric, you’ve got a gain of $425,000 which means that your state and federal taxes on the sale will be $85,000.” Cedric left saddened and went to Tough Times Bar to drown his sorrows. As he was having his fifth beer, a biker sat down beside him. “You look low man”, the biker said. “Yeah, I guess I shouldn’t be upset, but I learned that in selling a condo I bought for investment that I’m going to owe a lot of taxes”. The biker frowned for a second and said, “what are you going to do with the money?” That question caught Cedric a bit off guard and caused him to be suspicious. “Why are you askin?” Cedric responded. “Whoa man, just thought if you was going to invest in other real estate you could defer some taxes”, the biker said raising his open hands. “What?” Cedric replied.

“I was sellin my garage to another dude because I needed a bigger one for my custom bike business. My lawyer put me onto this trick called a Like Kind Exchange. And I rolled all my gain into my new building and paid zero taxes.” “Really?” Cedric asked. “I’m not shittin’ ya man?” said the Biker. “Thanks”, Cedric said, “what are you drinking, I’m buying”, Cedric continued, “Bartender give this guy whatever he wants to drink”.

The next day Cedric called his lawyer, “Have you ever heard of a like kind exchange?” “Yeah, but you should talk to a tax lawyer about that, one of my partners here a Mr. Ito Brassballs can help you.” Cedric made an appointment with Ito.