Vol. 9, No. 1, Pg. 26. Deferred Like-Kind Exchanges.

• Author: By J. Munford Scott Jr.

South Carolina Lawyer

1997.

Vol. 9, No. 1, Pg. 26.

Deferred Like-Kind Exchanges

26Deferred Like-Kind ExchangesBy J. Munford Scott Jr.GENERAL RULE - TAX ON GAINS

Under Internal Revenue Code §1001(c), gains from the exchange of property are generally recognized for tax purposes, as are gains on sales of such property. However, some types of exchanges do not give rise to taxable gains. One such exchange transaction is the like-kind exchange under §1031 of the Code.

LIKE-KIND EXCHANGES DEFER TAX

A basic like-kind exchange is a transaction in which one party transfers property held for productive use in a trade or business or for investment to another party in return for other property of like-kind, which is then held either for productive use in a trade or business or for investment. The basic requirements for a like-kind exchange are set forth in § 1031(a)(3)(A) and (B) of the Code.

A deferred like-kind exchange, as opposed to a basic exchange, is one in which one party relinquishes property in exchange for replacement property that is identified and transferred some time after the transfer of the relinquished property. In a basic exchange, the parties exchange the properties simultaneously. In a deferred exchange, the replacement property may not be obtained until some time after the transfer of the original property.

The Code provides that the property received in exchange for the original property will not be considered like-kind unless the property is identified within 45 days of the transfer of the original property (the identification period), and the property is actually received within the earlier of 180 days of the transfer of the original property or the due date, including extensions, of the taxpayer's return for the year of the transfer of the original property (the exchange period).

1991 Regulations. Regulations covering deferred like-kind exchanges were finalized in 1991 and apply generally to exchanges taking place on or after June 10, 1991. The regulations define a deferred exchange as one in which, pursuant to an agreement, the taxpayer transfers the original property held for productive use in a trade or business or for investment (the relinquished property), and subsequently receives property to be so held (the replacement property). Treas. Reg. § 1.1031(k) - 1(a) (1991).

The primary issues surrounding these transactions concern the doctrine of constructive receipt. The regulations contain safe harbors to prevent the doctrine of constructive receipt from nullifying the favorable tax effects of § 1031.

A taxpayer is in constructive receipt of money at the time the money is credited to the taxpayer's account; set apart for the taxpayer; made available to the taxpayer so that he could draw on it at any time; or made available so that he could draw on it if notice of intention to do so is given. A taxpayer is not in constructive receipt as long as actual receipt is subject to substantial limitations or restrictions, at least not until such limitations or restrictions lapse, expire, or are waived. Treas. Reg. § 1.1031-(k)-1(f)(2).)

If the taxpayer is ever in constructive receipt of money constituting consideration for the transfer of the original property, the transaction will be considered a sale and thus fully taxable.

IDENTIFICATION AND REPLACEMENT PERIODS

The identification and replacement period requirements are set out in the Code as noted above. However, several important aspectsare set forth in the regulations. The regulations provide that if the taxpayer transfers more than one relinquished property in the exchange, the identification and exchange periods begin on the date the first of such properties is transferred. Treas. Reg. § 1.1031(k) - 1(b)(2)(iii) (1991). While the identification period is straightforward enough (i.e., 45 days from the first transfer of relinquished property), the period for receipt of replacement property is somewhat more confusing. Its operation is clearly illustrated by an example based on the regulations:

Mr. Blinton transfers hotel property at 1600 Pennsylvania Ave. to Mr. Cole on 11/16/96. The identification period thus ends at midnight on 12/31/96. The replacement period ends at midnight on 4/15/97, the due date for Mr. Blinton's return. However, Mr. Blinton gets an automatic six-month extension to 10/15/97 to file the 1996 return. Therefore, the replacement period will end on 5/15/ 97, the date that is 180 days from the date of the transfer of 1600 Pennsylvania Ave. Reg. 1.1031(k) - 1(b)(3).

The regulations also provide that property that is actually received by the taxpayer prior to the end of the identification period (although not formally identified) will be considered timely identified. Treas. Reg. § 1.1031(k) - 1(c)(1) (1991).

IDENTIFYING REPLACEMENT PROPERTY

The manner set forth in the regulations for identifying replacement property is very detailed and should be strictly followed. The property must be identified in a

28writing, signed by the taxpayer and sent before the end of the identification period to either the person obligated to transfer the replacement property (even if a disqualified person) or any other person involved in the exchange (e.g., intermediary, escrow agent, title company) other than the taxpayer or a disqualified person. Treas. Reg. § 1.1031(k) - 1(c)(2) (1991).

Also, an identification by agreement for the exchange of properties signed by all parties to the agreement before the end of the identification period will be a valid identification. Id. The replacement property must be unambiguously described in the identification. The best way would be by legal description, although street address and distinguishable name are methods cited by the regulations as satisfying this requirement.

MULTIPLE PROPERTY IDENTIFICATION

The regulations provide three methods by which alternative or multiple properties can be identified. The first such method is the three property...