Ten Stupid Things Smart People Do To Mess Up Their Tax-Deferred Exchange Part 2

Posted on: June 22, 2007

Toija J. Beutler, Esq., Sr. Vice President/NW Regional Manager of Investment Property Exchange Services, Inc. (IPX1031), shares with us ten ways exchanges fail to produce the tax savings investors desire. This list has been posted as a two-part series with points 5 through 1 explained in this blog post. Click here to read Part 1 of this post.

5. Investors move into the replacement property right after the exchange. Patience, please! Although all real property is like kind with all real property (See Number 6, above) this is not true when it comes to personal use of property. Tax-deferred exchanges are limited to investment and business properties. If the Exchanger sell a rental house, buys a condo in Palm Desert and quickly begins to use that property for personal use (second or retirement home) the IRS will disallow the exchange for failure to have the appropriate “investment” intent. Patience is what is called for. After consulting with a tax advisor most Exchangers will understand that a rental period of one to two years is a safer way to proceed.

4. Investors don’t talk to their tax/legal adviser. I know, I know. They cost money. Still, although the tax and legal advisers may not know much about exchanges, they know their client. Consultation with the adviser is essential in deciding whether an exchange is necessary or appropriate. What if the relinquished property has a small gain or perhaps even a loss? In this scenario there is rarely a need for an exchange. Or, what if the investor has losses in other business activities? This could eliminate the need for an exchange. Only their tax adviser knows.

3. Investors call the exchange company after closing their sale. Too late. Much too late. The IRS requirement is that the exchange intent be documented at the time of closing. The case law is quite clear. Once the sale closes it is too late to put an exchange together. Short of rescinding the original sale, there is no way to “fix” the problem. Sorry, it’s fraud, even if we aren’t likely to get caught!

2. Investors miss a deadline. These deadlines are carved in stone. This is the hardest part of tax-deferred exchanges. If the Exchanger is unable to identify the replacement property within the 45-day identification period the exchange fails and they must pay their capital gain tax. If the Exchanger is unable to close the purchase of replacement property within the 180-day exchange period the exchange fails and they must pay their capital gain tax. Short of a “Presidentially declared emergency” (i.e., 9/11) the Treasury Department does not have the authority to extend the deadlines so the exchange companies certainly do not have the ability to extend the deadlines. This is another situation where the IRS, backed by the Tax Court, has shown that they do not play nice with Taxpayers (note I do not refer to them as “Exchangers”) who try to get around these deadlines.

1. Investors think exchanges are a do-it-yourself technique. No, you can’t do-it-yourself. Even in a beautiful “simultaneous” exchange the IRS rules require that there be exchange documentation and the rules prohibit the Exchanger from receiving, or having any right to receive, cash from the sale. Exchangers need a QI for two reasons. First, the QI must produce exchange documentation that meets some very specific legal requirements. Second, the QI must hold the cash or control the cash (i.e., give instructions to the closer to move the money to the escrow where the purchase is going to take place). Exchangers who try to do-it-yourself are called “Taxpayers.”