As a real estate investor or buyer, you are faced with a myriad of issues in real estate specially when it comes to trying to avoid paying taxes by deferring those taxes to a new property. I will provide yourself with information about the exchange process that will help you to comply with IRS requirements in regards to purchase and sale contract – whether it be for a relinquished property (property to be disposed of in an exchange) or replacement property (property to be acquired in an exchange).
If the purchase contract is not assigned to the QI(Qualified Intermediary) and notice thereof not given to the other party at or before the transfer of the property, the taxpayer will be treated as if they transferred the property directly to the other party with no involvement of a QI(Qualified Intermediary).
The IRS reiterated this requirement in Private Letter Ruling 200130001, wherein the taxpayers were required to pay tax on their gain from the sale of two properties because no notice of their assignment to the QI was given to the purchasers of their relinquished properties. This is a harsh result, but one that is easily avoided by taking these three simple steps:
First, if you are is selling non-owner occupied property, determine whether they intend to do an exchange and, if so, make sure that they engage the services of a reputable QI well before closing.
Second, You or your agent must inform the other parties to the contract about the exchange and that the contract will be assigned to the QI. You should also inform the other party that, notwithstanding the assignment to the QI, you remain the real party in interest and their rights to enforce the contract remain unaffected by the assignment. Additionally, you should add a clause in the contract (your QI can provide this language) – by way of an addendum – whereby the other party agrees to cooperate in the exchange. This additional clause notifies the other party that your client is doing an exchange and – more importantly – helps protect against the possibility of that party later refusing to cooperate in the transaction (e.g. refusing to acknowledge the assignment).
Third, confirm with your QI and the closer to confirm that they have obtained – before transfer of the property – a written assignment and acknowledgment thereof. Both the assignment and the acknowledgment are typically executed by all parties at closing.
Beginning with the close of the Relinquished Property, you have 45 days to identify the properties you intend to purchase and 180 days (or the due date for your tax return – whichever is earlier) to complete the acquisition of those properties. In addition, the 45 day identification period and the 180 day exchange period are calendar days. If the 45th day or 180th day falls on a weekend or holiday, the deadlines still apply. There are no extensions for Saturdays, Sundays, or legal holidays. No extensions are allowed on the 45 day deadline.
Let me know if you have any questions!
Alfredo Bustamante
