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

Common Exchange Questions and Answers

Let's cover some of the typical questions encountered on a daily basis.

Equity and Gain

Is my tax based on my equity or my taxable gain?

Tax is calculated upon the taxable gain. Gain and Equity are two separate and distinct items. To determine your gain, identify your original purchase price, deduct any depreciation, which has been previously reported, then add the value of any improvements, which have been made to the property. The resulting figure will reflect your cost or tax basis. Your gain is then calculated by subtracting the cost basis from the net sales price.

Deferring All Gain

Is there a simple rule for structuring an exchange where all the taxable gain will be deferred?

Yes, if you:

1. Purchase a replacement property which is equal to or greater in value than the net selling price of your relinquished (exchange) property, and
   
   
2. Move all equity from one property to the other; the gain will be totally deferred.

Definition of Like-Kind

What are the rules regarding the exchange of like-kind properties? May I exchange a vacant parcel of land for an improved property or a rental house for a multiple unit building?

Yes, like-kind refers more to the type of investment than to the type of property. Think in terms of investment real estate for investment real estate, business assets for business assets, etc.

Simultaneous Exchange Pitfalls

Is it possible to complete a simultaneous exchange without an intermediary or an exchange agreement?

While it may be possible it may not be wise. With the Safe Harbor addition of qualified intermediaries in the Treasury Regulations and the recent adoption of good funds laws in several states, it is very difficult to close a simultaneous exchange without the benefit of either an intermediary or exchange agreement. Since two closing entities cannot hold the same exchange funds on the same day, serious constructive receipt and other legal issues arise for the Exchangor attempting such a simultaneous transaction.

The addition of the intermediary Safe Harbor was an effort to abate the practice of attempting these marginal transactions. It is the view of most tax professionals that an exchange completed without an intermediary or an exchange agreement will not qualify for deferred gain treatment. And if already completed, the transaction would not pass an IRS examination due to constructive receipt and structural exchange discrepancies. The investment in a qualified intermediary is insignificant in comparison to the tax risk associated with attempting an exchange, which could be easily disqualified.

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