The Real Estate Exchange
Under Section 1031 of the Internal
Revenue Code
Facilitated by an Exchange
Intermediary
By Richard M. Heller, Esquire,
CCIM, CEC
President, R.E.I. Consultants,
Ltd
For some time, tax laws have allowed
the exchange of property
for other like-kind property without
triggering a gain. However, there were not clear rules, and the fear of
the IRS challenging and ultimately reversing exchanges scared off many
potential "traders". On May 1, 1991, the I.R.S. clarified the rules for
tax deferred exchanges through new regulations, citing specific rules in
which a deferred exchange will work.
There are "safe harbors" under the
regulations but we only address the function of the intermediary here.
This method, and seemingly the simplest, is to "trade" with an exchange
intermediary. The person wishing to make the exchange (the exchanger) agrees
to relinquish unwanted property to the intermediary in exchange for a replacement
property to be named. The intermediary then becomes the seller of the relinquished
property and, using the proceeds from the sale, purchases the replacement
property. Then new property is given to the exchanger, thus completing
the transaction.
The exchanger handles the sale of
the relinquished property much like any other sale: choosing the realtor,
setting or accepting the terms of the sale, even offering financing. Similarly,
the choice of the replacement property and all terms of purchase are completely
up to the exchanger. The intermediary is named in the sale and purchase
agreements as the seller or buyer, respectively, and acts as a trustee
for any proceeds until the entire transaction is completed. To all other
parties, the sale and purchase go on as usual.
To protect the exchanger, title
passes directly to the ultimate buyer and is received directly from the
owner of the replacement property. Any funds from the sale of the relinquished
property are held in trust, in insured investments, with interest accruing
to the exchanger. In this way, all of the required regulations are met,
effecting the exchange in the safest manner. The IRS requires an "Exchange".
The exchanger should not enter into a sales or purchase contract, but rather
should agree to exchange the relinquished property for other like-kind
property. During the exchange period, the exchanger cannot receive or control
cash proceeds from the sale of the relinquished property. The proposed
regulations clarify the case of an exchange intermediary when the buyer
of the relinquished property and the seller of the replacement property
are not the same party.
A "Qualified" intermediary is defined
as a person who: 1) Is not related to the exchanger; a related party, for
example, would be any attorney, accountant, or real estate broker who had
represented the taxpayer within two years of the taxpayer disposing of
their property; 2) Acts for a fee; and 3) Acts to facilitate the exchange
by entering into an agreement with the exchanger to acquire the relinquished
property, acquire the replacement property, and transfer the replacement
property to the exchanger.
The relinquished and replacement
property must be of like-kind and be held for productive use in trade or
business or for investment.
