9/13/01 #12/A: D, ND, TV
Release: Upon Receipt
Subject: News you can use: A tax-deferred transaction called the like-kind exchange
Contact: K. Jerry Smith, jsmith@websterrogers.com; Donna Winchester, dwinchester@websterrogers.com; 843-665-5900

FLORENCE, SC — “There’s little left that’s tax-free,” says Tony Wrobel, CPA, a partner with Webster, Rogers and Company, LLP, a regional accounting and consulting firm. “Tax-deferral is the next best thing.”

Wrobel offers clients expert advice about a tax-deferred transaction called the like-kind exchange. Provided for by Section 1031 of the Internal Revenue Code, this transaction is an effective tax strategy.

During a traditional real estate sale, the property owner pays income taxes on any recognized gain. But a like-kind exchange allows the owner of one property to trade it for another property with no immediate tax liability.

The transaction itself is not subject to federal or South Carolina income taxes. The gain on the relinquished property is delayed until sometime in the future, usually when the new or replacement property is sold.

Wrobel adds, “The (newest) property can be exchanged over and over and over again.” In effect, the tax savings on the initial exchange can be perpetually deferred. If the replacement property passes into the owner’s estate, the heirs may be accorded a “stepped-up basis” in the property. In other words, the value of the inherited replacement property is determined by its fair-market value at the time of the owner’s death, not the owner’s original cost basis. More good news — if the heir sells this property, its stepped-up basis can reduce, or even eliminate, taxable gain on the sale.

So, why don't more people use this excellent investment strategy? Probably because there are so many misconceptions about what constitutes a like-kind exchange. The most common misunderstanding is that the exchange has to be between two people who want each other’s property. A direct, or “two-party” exchange, is allowable but extremely rare.

Most deferred exchanges include at least four people: the exchangor, who wants to relinquish, or replace, his property; the buyer, who wants to acquire the exchangor’s relinquished property; the seller, who has the replacement property that the exchangor wants; and the intermediary, the person who serves as a go-between and orchestrates the transactions.

People also wrongly assume that the exchange must occur simultaneously. Again, while a simultaneous exchange is perfectly acceptable, it is the exception rather than the rule. In a deferred exchange, properties do not have to close at the same time. There is, however, a stipulation that the replacement property must be identified and then close within 180 days of the transfer of the relinquished property.

And finally, many assume that like-kind exchanges must involve properties that are identical — an office building must be exchanged for an office building, for example, or raw land must be exchanged for raw land. In this context of Code Section 1031, however, the term “like-kind” only means that real property must be exchanged for real property. (Note: Although personal property is not addressed here, it can also qualify for like-kind exchange, provided the two properties fall within the same designated class.)

All of this information is a broad overview of the like-kind exchange. As with most tax planning, the benefits of a tax-deferred exchange can best be determined by a tax professional knowledgeable about IRS guidelines. But when properly structured and executed, the like-kind exchange is a great tax-savings strategy available to anyone who owns investment or business real estate.

To obtain more information about this and many more topics, contact the nearest Webster, Rogers & Company office, and visit www.websterrogers.com. Webster, Rogers & Company, LLP is a regional accounting and consulting firm, with offices in Florence, Myrtle Beach, Georgetown, Charleston, and Sumter.