Don't get drilled on
a property swap
I'm a dentist and have owned my office building
for eight years. About two years ago, I began planning a larger office building
for my practice. I contracted for land, went through approvals, closed on the
property and started construction. I'm set to sell my present building and need
all the money from the sale for construction.
I've been told I have to pay 15-percent capital gains on the sale unless I give
all the money to an intermediary, and then hope to get it back in some scheme.
The main problem, apparently, is I bought the replacement property before the
sale of the existing property. I will be able to lease back the old office for
a while, but the new owner wants to take occupancy within a reasonable period.
But how could I sell my existing office and then hope to find a replacement office?
-- Dr. Jack
I'd hate to see you get drilled with capital-gains tax, doc. Of
course, the best way to plan for such a swap, known as a 1031 exchange, is when
you first identify that replacement property.
I'll spare you
the preventive lecture. But there's still a chance you may be able to get around
that painful capital-gains tax, providing you haven't accepted that check for
your old building. Time is of the essence, however.
sake, a 1031 exchange, otherwise known as a like-kind exchange, tax-deferred exchange,
or "Starker" exchange, is a handy way for real estate investors to defer
the payment of capital-gains tax on their transactions.
you sell investment real estate, you can use the proceeds to buy another income
property or properties without paying capital-gains tax, and continue to roll
these properties over into others over the years until you decide to cash out
the final asset(s), at which point you'll pay that 15-percent capital-gains tax
rate (recently reduced from 20 percent).
as you call it, is used in an estimated 75 percent of all commercial building
purchases on the West Coast, say national tax experts.
typical 1031 exchange, investors have 45 days to identify three potential replacement
properties to the IRS and a 180-day period running simultaneously to close on
one or all of them. Exchangers must reinvest all proceeds from the sale of their
old property, and put the monies in trust with a third-party intermediary, also
known as an exchange accommodation titleholder. Additionally, equity held by the
investor in the new property must equal or exceed the equity held in the old one.
IRS rulings in recent years cleared the way for a couple of nuanced 1031 transactions:
the construction exchange, or improvement exchange, where you build your replacement
property (i.e., that new office building you're constructing), and the reverse
exchange, where you (and I mean you) buy the replacement property first before
selling the exchange property. Both, particularly the latter, can get a little
A good tax accountant should be able to tell you
if your deal, as it stands, can be rearranged to qualify as a 1031, and most sizable
title companies can either serve as intermediaries or help you find one. Intermediaries
generally charge between $250 and $3,000, depending on the complexity of the transaction.
you can proceed under a 1031 structure, you may need to immediately identify that
new property you're building to the IRS as the replacement. You'll also want the
new building to be finished when you formally exchange into it. If it's only 80-percent
to 90-percent ready when that 180-day period elapses, the IRS will ultimately
give you credit toward just the portion of the project completed.
proceed to a tax expert immediately, doc, and don't bite down for at least two
hours after leaving the office.