TAX FREE INCOME & TAX-DEFERMENT THROUGH
REAL ESTATE ExchangeS

That’s right, you can receive the “Best Of Both Worlds”, by taking advantage of a Real Estate Exchange. A Tax-Deferment for both state and federal income tax associated with the gain (profit) and tax free income by placing a mortgage against the relinquished property prior to giving up legal title.

This concept allows the Taxpayer (seller) of business or investment held property to take advantage of an Exchangeand still receive cash, which is not taxable if the transaction is structured properly.

The following example explains how this concept works. Let's assume Mr. & Mrs. Taxpayer are disposing of a four unit apartment building. The price is $110,000. and today, it is mortgage free. Mr. & Mrs. Taxpayer have made a decision to structure their transaction as a Real Estate Exchangeand defer both state and federal income tax based on their gain. Let's also assume that their Gain is $80,000., taxed at a rate of approximately 30 percent between recapture depreciation, state and federal income tax which spells a tax liability of $24,000, if the transaction is treated as a sale. But, Mr. & Mrs. Taxpayer have decided that rather than turning over $24,000 to Uncle Sam in the form of taxes that they would structure their transaction as a Real Estate Exchangeand defer both state and federal income tax.

Today, a Real Estate Exchangemeans that the Taxpayer's are disposing of a business or investment held property and still need to locate a buyer for their property. The buyer still gives cash the day of closing but the cash does not go to the Taxpayers but to the Qualified Intermediary representing the Taxpayers. This cash goes into a Qualified Escrow Account and is used by the Taxpayers to acquire the replacement property deemed of a like-kind.

This all sounds great but the Taxpayer's decided that they only want to re-invest $60,000 of their $110,000 back into other Real Estate deemed of a like-kind to qualify as a Real Estate Exchange.

Well, if they take the $50,000 which is the difference of the $110,000 price that they are disposing for and only reinvest the balance, which is $60,000 they will be taxable on the $50,000 as "cash boot".

But if the Taxpayer's decided to take advantage of “Best Of Both Worlds”‚ meaning receiving the tax-deferment on their gain and tax-free income rather than cash boot at closing in the amount of $50,000 they can accomplish both as follows.

Prior to closing of the relinquished property, Mr. & Mrs. Taxpayer go out and put a mortgage of $50,000 against their mortgage-free property of $110,000. The mortgagee liens the property and gives the Taxpayer's $50,000 which is not subject to taxation because its a debt not a legal form of disposition. Remember the placing of this mortgage against the relinquished property is going to happen before the Taxpayer's dispose of it to the buyer. Current case law favors the position that the Taxpayer's can obtain tax-free cash from an increase in debt on the Taxpayer's property prior to closing. 

By the Taxpayer's executing an Exchangeand putting a mortgage against their relinquished property prior to closing it has no affect on the buyer. The buyer still acquires the relinquished property for the same amount and the mortgage that the Taxpayer's put against the relinquished property prior to closing is discharged (paid off) at the closing. The only affect is to the Taxpayer's who have reduced their equity position from $110,000 down to $60,000, but also have received $50,000 in cash prior to the closing which is not taxable. The Taxpayer's still need to reinvest the net proceeds from the closing meaning the $60,000 into a minimum value of $110,000 in order to be fully tax-deferred as well.

This concept if structured properly can allow owners of business or investment held property that are disposing for what ever reason to take advantage of an Exchangeby going back into other business or investment held property of their choice and still pull cash out prior to closing of the relinquished property which is not subject to taxation.

 Before anyone executes this concept they should consult with their Tax Advisor and a Qualified Intermediary.