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A deferred like-kind exchange, commonly referred to as a delayed exchange, takes place when the eligible like-kind property acquired in the exchange is received subsequent to the relinquishing of the property that’s being given up. Following transfers that occurred after December 31, 2017, both the property relinquished and the property acquired need to be real property for IRC 1031 to be applicable.
For a taxpayer to be eligible for a like-kind exchange, they need to adhere to the statutory requirements concerning the timely identification and receipt of the replacement property by:
Caution: There’s a common misconception among taxpayers that delayed exchange rules might allow them to sell property and still be eligible for deferred gain treatment as long as they purchase new property within 45 days. However, if a taxpayer sells a property outright and receives payment for it, they cannot benefit from like-kind exchange treatment.
To identify the replacement property, written notice must be provided to the transfer agent or any other party involved in the exchange (including all parties engaged in the exchange), such as an escrow agent or a title company.
The notice must:
Note, however, that due to the Tax Cuts and Jobs Act of 2017 (TCJA), personal property no longer qualifies for the deferral of gain in a like-kind exchange. Following transfers that occurred after December 31, 2017, both the relinquished property and the replacement property must be real property for IRC 1031 to be applicable. However, there’s a transitional rule where the pre-TCJA rules apply to exchanges of personal property if the relinquished property was disposed of or the replacement property was received on or before December 31, 2017.
In situations where a taxpayer wishes to exchange property, locating replacement property might pose challenges, particularly if the taxpayer is interested in a different location.
Example: Let’s consider Grace, who has a buyer lined up for her commercial office building in Phoenix. She aims to find a similar building in the Detroit area for a like-kind exchange. If she accepts cash from the Phoenix buyer, she’ll have to recognize capital gain. Grace needs to find a building owner in Detroit willing to exchange the building for her Phoenix property, which might be unlikely.
In such scenarios, taxpayers often turn to a “qualified intermediary” to facilitate the exchange. The deferred exchange regulations outline four secure avenues that involve specific security and guarantee arrangements. The use of a qualified intermediary is a common approach, as it’s one of the safe harbors that can demonstrate that the taxpayer hasn’t actually received money or other property. A qualified intermediary enters into an agreement with the taxpayer to facilitate the exchange. This intermediary acquires the taxpayer’s property, transfers it to another party, and transfers replacement property to the taxpayer.
The identity of the person acquiring the taxpayer’s property and the person from whom the taxpayer receives property may be known or unknown to the taxpayer – everything is managed through the intermediary.
Note: A qualified intermediary cannot be the taxpayer’s agent, such as someone who acted as the taxpayer’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the two years preceding the transfer. Additionally, the intermediary cannot have a certain relationship to the taxpayer. An example is the case of Frank J. Blangiardo, where a like-kind exchange failed because there wasn’t a direct exchange of like-kind property. Even though an intermediary was used, it was determined that the intermediary (the taxpayer’s son, who was an attorney) was not qualified due to his relationship to the taxpayer.
The qualified intermediary is responsible for ensuring that the exchange occurs within the required timeframe, that legal obligations such as title recordings are fulfilled, and that the taxpayer does not receive cash or unlike property until the exchange is finalized.
In most cases, the exchange is considered complete when the title to the replacement property is transferred to the taxpayer.
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