Tax Rules For Multi-Party Property Exchanges
Multi-party property exchanges involve specific IRS tax rules. If you are planning to engage in this type of transaction, it is important to understand your responsibilities as a taxpayer.
Two-party exchanges are usually not feasible in reality. Seldom does Seller have the exact property Buyer wants, and vice versa. Complicated multi-party exchanges have become increasingly common. In order to avoid pitfalls, structuring such exchanges generally requires assistance from experts (which can be expensive). Exchanges are often structured using one of a number of possible formats: e.g., escrow accounts, trusts, and qualified intermediaries. Safe harbor rules outline arrangements that are sanctioned under Section 1031. The following examples illustrate possible structuring of multi-party exchange transactions, which qualify for Section 1031 treatment:
“ Example 1 - Multi-Party Exchange - Tony wants to exchange an investment lot to avoid currently paying tax on the sizable gain he would have if he sold it. He hopes to replace the lot with a rental property owned by Teresa. Unfortunately, Teresa needs cash and prefers a sale to an exchange. In the meantime, Ted offers to buy Tony’s lot for cash. Possible solution: Ted could buy the rental from Teresa and exchange it with Tony for the lot. This would satisfy all parties involved: Ted would have the lot, Tony would accomplish his exchange, and Teresa would have the cash from the sale of the rental. ”
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“ Example 2 - Exchange vs. Outright Sale - Tony owns a duplex, which he wants to exchange for 5 lots owned by Clarence. (The FMV of the 5 lots is less than 200% of the FMV of the duplex, so the no-more-than-3 replacement properties rule isn’t violated.) Pete wants to buy the duplex. Bob acts as accommodator in the exchange transaction. To accomplish the exchange, Bob sets up a number of escrow agreements, providing for simultaneous transactions in which he:(1) Buys the 5 lots held by Clarence.(2) Exchanges the lots with Tony for the duplex.(3) Sells the duplex to Pete.Each transaction is contingent on the successful closing of the others. The cash placed in escrow is earmarked for the acquisition of the 5 lots; and the agreements do not allow Tony access to the cash at any time.Example 2 is based on Barker (1980) 74 TC 555 in which IRS claimed that Barker’s transactions were simply a sale and repurchase and the gain on the sale was taxable. The Tax Court overruled, stating that the transfers of the lots for the duplex were mutually dependent transactions and could not be separated. ”
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