Most sellers of investment properties think that the only way to stay invested in CRE and still defer gain taxes is to use a 1031 exchange. But, there is a little-known and older alternative that can also provide additional advantages. It is called a "Like Kind Exchange", and is part of the IRC Section 453 installment sale regulations.
It enables a portion of the sale proceeds equal to the seller's basis in the relinquished property to be put into a replacement property without incurring a pro-rata share of gain taxes when transferred. Any amount of the sale proceeds put in above basis would be treated as taxable "boot". Then, the balance of the sale proceeds, which now would represent 100% taxable gain, can be deferred out into the future under the more flexible and customized terms of the installment sale.
And, in order to assure this funding allocation flexibility, mitigate the risk of buyer default regarding the installment payments and not impede the sale from the buyer's perspective, I would recommend constructing the installment sale using the licensed, patent-pending 453 Commercial Loan program or the Structured Sale program.
Using this "Like Kind Exchange" provision offers the seller several advantages. First, the seller is not restricted to properties equal or larger in size than the relinquished property, but can now consider smaller properties, too. And, by transferring only basis into the replacement property, including any desired after-tax "boot" which would now also be classified as basis in the replacement property, the seller has maximized the replacement property's depreciation potential.
Next, by using an installment sale construct, the seller is able to "cash out" on whatever basis the seller desires, and is not restricted by the illiquid, "all or nothing" 1031 exchange requirements. Remember, there only needs to be one installment payment in a tax year subsequent to the year of sale in order to qualify for installment sale treatment, and that could be many years later. In fact, it could be paid in the same timeframe the seller intended to "cash out" of a 1031 exchange if a "same size or larger" property had been found initially.
Furthermore, the contract nature of the installment sale , when paid by a lender or insurer under one of the programs mentioned above, can provide return stability and predictability when the market for investment real estate at the "cashing out" point may be unpredictable. And, the installment sale portion will have been separated from the operational risks of the replacement property.
Thus, for those sellers still wanting to stay "in the game", this arrangement may provide the maximum flexibility and tax-deferred diversification opportunity.
For more information, call me (Bruce Gordon) at (913) 685-0755.
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