Volume 9 Issue 1
Selling (Exchanging) Real Estate Without Tax
© by Tax & Business Professionals
"Gee, I didnt know you could do that," is the
lament often heard from owners of real property who discover, too late, that they could
have deferred (or avoided) income tax on its sale. Many people who own real estate give
little thought to planning for the transfer of ownership. For example, whether the real
estate is a personal residence (home) or investment or business property, the gain can
often be deferred with proper planning. (The following discussion does not apply to real
estate dealers who have an "inventory" of real property, unless it is clear that
some of the property is "not held for sale," but rather for
What is a Like-Kind
For some time, Congress has allowed real estate and other
assets (like trucks) held for investment or business purposes to be exchanged for similar
assets (hence, the term "like-kind exchange") without paying income tax. Such
"like-kind" tax deferrals often involve two, three, and four parties, so
professionals are often involved. Leaving the technicalities aside for the moment, if,
instead of receiving the proceeds of a sale, the proceeds are invested in replacement
property without the seller-owner getting their "mitts on the money" (actual or
constructive possession), gain can be deferred. In addition to deferring the gain, under
current tax law, if real estate is involved, the would-be seller is free to pick any kind
of replacement real property.
For example, lets say you own vacant investment land
(called Property-A) in "X-ville" which has appreciated but generates no rent to
pay increasing property taxes. You believe you can sell Property-A and buy three condos in
"X-ville" with positive cash flow, since there is a shortage of housing in
Instead of simply selling Property-A and "taking the
money," there are alternatives that defer the tax. Lets assume Property-A was
purchased 15 years ago for $20,000 and is paid off, and you are now offered $120,000 for
it. Let's further assume that State (7%) and Federal (28%) capital gains taxes total 35%.
Ignoring real estate commissions on the $100,000 of capital gains, 35% or $35,000 will go
to taxing authorities, and there will be $85,000 left to invest ($120,000-$35,000).
Rather than pay the $35,000 in tax on Property-A now, the
entire $120,000 (again ignoring commissions and costs) could be "rolled-over" to
obtain $120,000 of replacement property ("3-Condos," hereafter) using the
like-kind exchange mechanism.
Here's How it Works
There are two basic ways to do a like-kind exchange: (1)
"simultaneous" and (2) "deferred." In a simultaneous exchange, the
3-Condos replacement property and Property-A are exchanged (sold) simultaneously. Since
both the sale of Property-A and the purchase of 3-Condos occur simultaneously (on the same
day), the owner never gets his/her "mitts on the money" so the gain is deferred.
While such simultaneous exchanges can be accomplished, they require the coordination and
cooperation of the purchaser of Property-A and the seller of 3-Condos. Often, due to a
lack of prior planning and cooperation of the buyer and seller, simultaneous exchanges are
A deferred exchange is the more common type. Usually the
would-be seller (owner of Property-A) does not want to run the risk of delaying a
potential sale and losing an interested buyer while looking for suitable replacement
property (3-Condos) for a simultaneous exchange. In this more common situation, the
would-be seller of Property-A can use an agent to hold the sales proceeds while looking
for replacement property. Under the deferred exchange rules (often called
"Starker" exchanges, after a well-known Tax Court case), the former owner of
Property-A has 45 days to identify the replacement property (3-Condos) and 180 days
(approximately) to purchase the same. Assuming these events happen within the prescribed
time periods, the State and Federal taxes are postponed or deferred until the replacement
property is sold.
What if Property-A is to be condemned for a new road; can the
gain on the condemnation proceeds be deferred using the same like-kind exchange concepts?
Yes. Owners of real estate who have condemned property can use essentially the same
like-kind deferral concepts to defer gain on condemned property.
Gain on personal residences can be deferred using another tax
mechanism, often called a "two-year roll-over" that allows the deferral of gain
on the sale of a personal residence if a replacement home is purchased within two years of
the sale. If the homes value has inflated, the "two-year roll-over" can
defer income tax on the sale of the old home if the cost of the new home equals or exceeds
the amount received for the old home. Stated differently, if the old home sells for
$150,000, the replacement home has to cost approximately $150,000 to defer all of the
potential gain. (Note, in both like-kind exchanges and two-year roll-overs, some cash can
be received and taxed without causing all of the gain to become subject to capital gains
Please remember that this newsletter is not designed to address
the technical details (and there are many) of like-kind exchanges. Instead, a newsletter
of this type focuses on introductory and planning concepts.
In our next issue, we will discuss
more advanced like-kind exchange considerations.
Previous Article | Next Article
List of Articles by Tax & Business Professionals
Published jointly by The Tax & Business Professionals, Inc. and the law firm of Newland & Associates as a service to their clients.
If you are a tax professional and would like more information about the subjects covered in this newsletter or any other tax and business matter, please call the Tax & Business Professionals, Inc. at (800)-553-6613, e-mail us at
, or visit our web site at http://www.tax-business.com.
For a full range of business law and tax-related services, call the law firm of Newland & Associates at (703) 330-0000.
If you are reading this newsletter but are not on our mailing list, and would like to be, please contact us at (800) 553-6613.
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.
You can search for information in the entire Authors Row section,
or in the entire site. For a more focused search, put your search word(s) in quotes.
Tax & Business Professionals Main | Authors Row Main | Home