A General Guide to Tax Deferred Exchanges
By: P. Patrick Ashouri, Esq.

Types of Exchanges

Although the vast majority of exchanges occurring presently are delayed exchanges, let us briefly explain a few other exchanging alternatives.

Simultaneous Exchange

As mentioned previously, prior to Congress modifying the Internal Revenue Code as to exchanges and formally approving the concept of delayed exchanging, virtually all exchanges were of the simultaneous type. To qualify as a simultaneous exchange, both the relinquished property and the replacement property must close and record on the same day.

Some investors still try to accomplish simultaneous exchanges, primarily to avoid or reduce the payment of multiple closing fees or exchange fees to a facilitator. There is significant danger and legal exposure in this attempt since many unforeseen events can cause the closing to be delayed on one of the properties, leaving the investor with a failed exchange and the obligation of taxes that would otherwise be deferred.

For example, if the properties are located in different counties, it is highly unlikely that the closing can take place on the same day. If two different title, escrow, closing firms or attorneys are involved, it is virtually impossible for both to have the funds to close in their possession on the same day. For instance, with "Good Funds” laws existing in many states, an escrow holder cannot disburse funds not actually in their possession.

Further, in directing an escrow holder to disburse funds for the purchase of the replacement property, it could be contended by the IRS that the investor had what is considered "constructive receipt" of the proceeds of the sale, and therefore taxes on the gain would be due. However the 1031 regulations contain what is referred to as a "Safe Harbor" provision, which does provide that in the event a facilitator or intermediary is used in a simultaneous exchange, and the transaction proves not to be simultaneous, the exchange will not fail simply for that reason.

Improvement and Construction Exchange

In some cases, the replacement property requires new construction or significant improvements to be completed in order to make it viable for the specific purpose the Exchangor has intended for the property. Such construction or improvements can be accomplished as part of the exchange process, with payments to contractors and other suppliers being made by the facilitator out of funds held in a trust account.

Therefore, if the replacement property is of lesser value than the relinquished property at the time of the original transaction, the improvement or construction costs can bring the value of the replacement property up to an exchange level or value which would allow the transaction to remain tax free.

Business or Personal Property Exchange

Although our discussion in this tutorial involves the typical exchange of real property, Internal Revenue Code Section 1031 does allow the exchange of many types of property other than real estate. Investors may exchange, for example, rail cars, trucks, ships, classic cars or live stock, among other assets. Therefore, business exchanges are a common transaction.

While the basic exchange rules are the same, certain complications arise in classifying the non-real estate assets into one of several categories or SIC classes so that they meet the associated like-kind requirements. While this is a simple enough process for the experienced facilitator, it can be thoroughly confusing for the uninitiated Exchangor, making the selection of his intermediary or facilitator extremely important to the successful structuring of the exchange.

If you desire additional information regarding business or personal property exchanges, please consult an experienced tax professional to first determine the classes of properties available to be exchanged. Then, remembering that all personal property must be exchanged within the same class, (locomotive for locomotive, collectible art for collectible art, pizza oven for pizza oven, etc.) assign values for the various assets within that class. These values collectively, will then reflect the value of the total exchange.

Also, some personal property and business items are not exchangeable. Most notable in his group are such items as goodwill or inventory.

Again, as mentioned above, do not undertake the planning of a business or personal property exchange without the assistance of an experienced tax professional. In any business exchange, the time and money you invest in planning will be well worth it when your transaction is deemed qualified.

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