Defer Taxes with a Like-Kind Exchange

If you are preparing to sell a business property that has increased quite a bit in value in the time you have owned it, the prospect of paying capital gains taxes on that increased value may be giving you nightmares. Fortunately, the Internal Revenue Service has a vehicle you can use to defer those gains: a Section 1031 exchange, often referred to as a like-kind or non-taxable exchange. The IRS will allow you to trade real business property for other real property of similar value without reporting any profit or paying capital gains taxes.

The rules governing like-kind exchanges could fill a book–in fact they do, IRS Publication 543–but a few stand out:

• You cannot claim tax deferral for any cash on which you take constructive receipt, in any way. For example, cash or unlike property received by one side or the other to balance out the transaction is taxed. Intrinsic value, such as the value of a customer list, also will be taxed.
• You have 45 days from the time you sell a property to identify what you are buying in exchange, and 180 days–or the due date of your tax return plus extensions, whichever is shorter–to complete the exchange.
• The definition of "real property" in a like-kind exchange concerns only how the property was held by its owner, not its type or character. You can exchange an office building for a six-flat, for example, or mineral rights for a par-3 golf course. On the other hand, the rules governing "personal property," such as a truck, are much more restrictive. Personal property in a like-kind exchange must be in the same general asset class or product class.

To qualify under Section 1031, the transaction can't involve an exchange of real property located inside the United States for real property located outside the United States. In other words, you can't exchange Illinois farmland for a French vineyard and receive a like-kind designation.

The Qualified Intermediary
Sounds great, right? But what are the chances of looking in your local paper and finding a business property you want, of similar value, being sold by an owner looking to do a like-kind exchange? Try fairly remote.

This is where the Qualified Intermediary (QI) comes in. QIs help their clients locate appropriate like-kind exchange properties, within statutory time limits, and then bring the two parties together. QIs hold the net sale proceeds in trust until the proceeds are used to purchase the exchange property.

QIs generally receive a referral fee, which is deducted from the selling agent's commission. To ensure that you receive the expertise and security that are vital for a successful 1031 exchange transaction, you should select a reputable qualified intermediary and qualified escrowee that:

1. Is subject to both internal and government audits;
2. Has FDIC, Errors and Omissions and Fidelity Bond insurance;
3. Has facilitated exchanges for at least 10 years; and
4. Has attorneys, CPAs and investment officers on staff.

Fear of capital gains taxes can kill the incentive to sell a business or investment property, especially when a long-held property couples an enormous increase in real value with years and even decades of depreciation write-offs. Like-kind exchanges can defer those taxes until it makes better financial sense to pay them.

Cole Taylor Bank's Trust Department has the expertise to help our customers utilize 1031 exchanges effectively. For more information, please contact us, and we will send you an email information packet.

Scott Nathanson, President, [email protected],
(312) 960-5316
Julianna Clementi, Vice President, [email protected],
(312) 960-5317
Coleen Danaher, Assistant Vice President, [email protected],
(312) 960-5318
Don Bender, Trust Officer, [email protected],
(312) 960-5336