If you are disposing of real estate held for business, rental or investment, and you plan to reinvest the proceeds in other real estate, don't sell it - EXCHANGE IT! Defer income taxes on the gain and put that money to work for you. Gomel & Davis can show you creative ways to make it happen.

The like-kind exchange rules of Internal Revenue Code §1031 are quite liberal. Almost any interest in real estate qualifies as like-kind exchange property, including standing timber in some states. An office building can be exchanged for raw land, apartments can be exchanged for a shopping center, etc. In many cases, personal property used in a business can also be exchanged. The taxpayer/Exchangor can be any type of legal entity. However, §1031 should not be used with seller-financed installment sales, or the sale of capital stock, a partnership interest, or property with a high tax basis (loss property).

To defer all taxes on the transaction, in simple terms, the taxpayer must exchange and reinvest the full gross proceeds. In other words, the Exchangor must not trade down in value or pull out cash. The tax deferral may be partial; if these tests are not met, the taxpayer will pay tax on that portion of cash or other nonlike-kind property ("boot") received in the exchange. When mortgages are involved, other rules must be addressed.

Timing and documentation are the most important aspects of a qualified exchange. Although permitted, most exchanges do not close simultaneously.

A like-kind exchange represents one of the few remaining "tax shelters" in real estate. Special attention is required to correctly plan related-party exchanges, personal property exchanges, and exchanges involving mortgages or taxable boot. If you need to acquire the replacement property before the relinquished property is sold, this "reverse exchange" requires other planning techniques. Gomel & Davis helps many clients take full advantage of the §1031 rules.

Greater Purchasing Power. If one intends to continue investing in real property, an exchange is usually preferable to a sale and purchase using after-tax dollars. Given today's federal and state tax rates, an exchange can provide as much as 25% more equity to acquire a more lucrative or appropriate Replacement Property. This effect is magnified through subsequent exchanges.

No Income Taxes Paid on Gains. As with most tax shelters, an important advantage is the ability to transfer appreciated property without incurring tax liability. Replacement Property can be held or subsequently exchanged so that taxes on the gain are only paid when the Exchangor chooses to conduct a taxable sale. For individuals, exchange property receives a step-up in basis at the Exchangor's death, so taxes on the gain can be avoided.

Consolidation or Diversification. The Exchangor may seek to convert from a larger, single real estate investment into multiple smaller properties of different types, in different markets, and in different locations to achieve reduction in risk or increase in potential for appreciation. Conversely, the Exchangor might seek to convert from multiple properties to a single property of equal or greater value to reduce management problems and achieve economies of scale.

Leverage up Total Investment. Where a combination of appreciation and debt reduction has led to increased equity, the Exchangor may exchange using greater debt into a more valuable property to increase the use of leverage and obtain appreciation on the lender's funds. For instance, an Exchangor can use financing to go from a $1,000,000 investment to a $5,000,000 investment.

Convert to Income Producing Property. The Exchangor's income needs may change, and an exchange allows conversion from speculative or investment property into rental or income producing property. For retirement income, many are exchanging into high grade, net leased property, such as commercial outparcels with national tenants.

Meet Relocation Needs. An Exchangor who is transferred or relocated may exchange to avoid becoming an absentee landlord. As a business expands it may need to exchange its current operating facility and move into a larger commercial facility.

Shift to Depreciable Property. In some cases, an Exchangor may exchange to shift his tax basis from property with low depreciation characteristics to property with a higher ratio or component of depreciable property, to increase cost recovery deductions.

Additional Costs and Complexity. Consummating a deferred exchange will increase transactional costs, including intermediary fees, additional attorney or tax advisor fees, and possibly additional settlement fees.

Mandatory Reinvestment. All net proceeds from the sale must be used for acquisition of the Replacement Property and may not be withdrawn by the Exchangor for other uses without adverse tax consequences. After some time has passed, equity may be withdrawn through a loan.

Lower Basis. The Replacement Property takes a carryover basis from the Relinquished Property, which will defer the gain that might be recognized until a future sale. The lower basis yields lower cost recovery deductions than would be available after a taxable sale and purchase.

Strict Requirements. The guidelines for completing a successful exchange must be followed to the letter, which limits flexibility, especially in timing.

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