Using Like-Kind Exchanges When Acquiring the Property First
Author: Scott Humphrey
In many cases, developers or business owners will identify the property they want to acquire before they sell one of their existing properties. In this situation, the property owner can still benefit from a like-kind exchange if properly structured.
Most like-kind exchanges are structured so the property is sold and the proceeds are then used to purchase replacement property. A “reverse” like-kind exchange has similar requirements, but follows a different approach by allowing for a qualified exchange accommodation arrangement (QEAA), also referred to as a “parking strategy,” to facilitate the exchange.
According to IRS guidance, property is held in a QEAA if the following requirements are met:
- Qualified indicia of property ownership (generally legal title) is held by an entity or person—the exchange accommodation titleholder (EAT)—that isn’t the taxpayer or a disqualified person. In addition, either such person or entity is subject to federal income tax or, if a pass-through entity, 90 percent of the shareholders or interest holders are subject to federal income tax.
- At the time the qualified indicia of property ownership is transferred to the EAT, it’s the taxpayer’s bona fide intent that the property held by the EAT is intended to qualify as property in a Section 1031 exchange.
- No later than five business days after the transfer of qualified indicia of property ownership to the EAT, the taxpayer and EAT enter into a QEAA.
- No later than 45 days after the transfer of qualified indicia of replacement property ownership to the EAT, the relinquished property is properly identified as outlined in IRS regulations.
- No later than 180 days after the transfer of qualified indicia of property ownership to the EAT, the property is transferred either directly or indirectly through a qualified intermediary (QI).
- The combined time period the relinquished property and the replacement property are held in a QEAA doesn’t exceed 180 days.
While the property is being held in a QEAA, the developer may still use the property. Normally, the building is rented back from the EAT by the developer and more than likely the loan will require a guaranty.
Reverse like-kind exchanges can be better explained with an example. Collin, like sister Hailey, also develops properties. The main difference is that Collin prefers to buy properties first and has found a great redevelopment opportunity in Denver. Collin doesn’t want to pay tax on the sale on one of his other properties, so he engages a §1031 exchange to set up an EAT and to act as the QI. The EAT signs a nonrecourse loan for the Denver property, guaranteed by Collin and his father, and takes title. As part of the arrangement, the EAT triple-net leases the property back to Collin, so Collin can begin remodeling the property. Next, Collin identifies a property in his current portfolio as the relinquished property within 45 days of the acquisition of the Denver building. Collin sells the property within 180 days of acquiring the Denver building using a QI and receives §1031 exchange deferral.
Real property like-kind exchanges are still a viable planning tool, as they survived tax reform; however, personal property is no longer eligible for like-kind treatment. If you have any questions about regular or reverse like-kind exchanges and how they may affect you or your company, contact Scott or your trusted BKD advisor.