Misconceptions of Real Estate Exchanges

Very often, owners (taxpayers) of business or investment held property go to their advi­sors with misconceptions about real estate exchanges. It is important to understand these misconceptions and to address and correct them early when planning a method of disposition. To correct misconceptions, advisors must determine what the taxpayer is trying to accomplish (their objectives) and to help the taxpayer develop an understanding of the rules and guidelines within which the exchange transaction must be structured in order to be viewed as an exchange for IRS purposes.

Unlike so many other areas of practice where professionals are dealing with events which have already occurred, exchanging under Internal Revenue Code Section 1031 usually requires proper planning and advice before a exchange transaction occurs.

For many, the misconceptions that exist in their minds have deterred them from structuring their transaction as a real estate exchange or, worse, have cost them taxes which need not have been paid. Between state (New York), federal income taxes and recapture of depreciation we are talking as much as approximately thirty percent (30%) of one’s gain today. Once a transaction has taken place (closed) as a sale it is too late to restructure it as an exchange. But, keep in mind, you can amend (change) a sale into an exchange any time before the closing and for the most part don’t even need the cooperation of the buyer to do so.

Too frequently taxpayers who have sold business or investment held properties find out after the fact that they could have avoided state and federal income tax on their trans­action had it been structured as a real estate exchange. Increasingly, such taxpayers are looking to real estate agents, tax advisors, and closing attorneys and claiming negligence if they have not been advised about Section 1031 of the Internal Revenue Code.

Today, this need not be the case. With the new Exchange Regulations taxpayers looking to structure the transaction as a real estate exchange can rely on the “Qualified Intermediary” safe-harbor. A professional Qualified Intermediary is one who facili­tates real estate exchanges. A professional Qualified Intermediary should have special training in negotiations, contract law, taxa­tion, investment analysis, escrow procedures and real estate practices as well as having a proven success record in the business of facilitating real estate exchanges. Choosing the right Qualified Intermediary could be the most important step toward developing a defensible exchange.

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