Real estate exchanging has become a mainstream way of disposing of one property & acquiring another in its place. Sophisticated investors commonly use this technique. For those who haven't yet exchanged, here are a few thoughts.
The government (IRS) allows a taxpayer currently owning real property held for use in their trade or business (such as investment property, retail, office, industrial, warehouse, multi-family, new land, etc.) to be exchanged for other real property to be used in their trade or business.
The technique may not be used for a primary residence, nor for a second home except under certain circumstances.
Basically, any real estate held as an investment, regardless of type, may be exchanged for any other real property, regardless of type (i.e., land for office, multi-family for retail, office for warehouse, etc.), provided that the new property will also be investment property.
While it is theoretically possible for two owners to sit at a closing table & exchange their respective properties, almost all exchanges today are non-simultaneous or deferred exchanges. This involves the use of a third party known as a qualified intermediary.
To preserve the capital gains tax deferred benefit, it is critically important that the taxpayer not receive cash (or any proceeds) at closing. Instead, the qualified intermediary holds the proceeds in a trust account releasing them to acquire a replacement property.
Since the purpose of a tax deferred exchange is to defer payment of capital gains tax to some future date, this process is only used where the taxpayer has a significant tax liability created through appreciation in the value of the property.
While the exchange process is pretty straightforward, there are several rules which must be followed. This is where communication with the taxpayer's accountant, attorney, real estate advisor & qualified intermediary work to make the transaction run smoothly.
If you have any questions about exchanging, feel free to ask us.