Like-Kind Property is not defined in a narrow way. You may exchange any property that, under state law, is considered real property for any property that, under state law, is also regarded as real property. You can exchange a commercial building for an apartment house, since both types of property are considered real property. You cannot exchange real property for any other kind of property, such as tangible property (e.g., equipment, automobiles, or trucks) or intangible property (e.g., copyrights, trademarks, or franchises).
You can identify up to three Fair Market Value (FMV) properties. You can identify more than three properties as long as the total combined FMV does not exceed 200 percent of the FMV of the property you sold (Relinquished Property). As a final option, you may identify any properties if you acquire at least 95 percent of the FMV of the properties you have identified.
For your property to qualify for a tax-deferred exchange, it must be “held for investment.” Unfortunately, neither the Internal Revenue Code nor the Internal Revenue Service Regulations provides an exact definition of “held for investment.”
One of the factors that the Internal Revenue Service looks at is the length of time you have held the property for investment. However, neither the Internal Revenue Code nor the Internal Revenue Service Regulations indicate how long you must keep a property for it to qualify as investment property. One source you can look to is a proposed, but not implemented, 1989 Internal Revenue Code change. This proposed change required the Exchangor to own the Relinquished Property for one year and the Replacement Property for one year after the exchange.
In a private letter ruling (PLR) 8429039, the Internal Revenue Service indicated a two-year minimum holding period would be sufficient. While private letter rulings do not establish legal precedent for all Exchangors, they still give you an idea of what the Internal Revenue Service is thinking.
Another source you can look to is a tax court case in which the Exchangor held their Relinquished Property for five months and 20 days (six months). The Tax Court deemed this period sufficient to be considered “held for investment.”
Most advisors recommend that the Exchangor hold the Relinquished Property and Replacement Property for at least 12 months. This recommendation is made for two reasons. The first reason is that a holding period of 12 months or more usually results in the Exchangor reporting the property in two different filing periods on their income tax returns. The second reason is that it reflects the holding period in an Internal Revenue Code change proposed but not passed by Congress. The Internal Revenue Service will also look at all the facts and circumstances concerning the Exchangor’s situation to determine whether the Exchangor intended to hold the Relinquished and Replacement properties “for investment.”
You cannot move into the property you acquire to replace the property you sold. If you do, it will not qualify as your Replacement Property. Moving into a Replacement Property would convert it into a principal residence or personal use property. If you rent out your Replacement Property for one to two years, you can then move into your Replacement Property.
No. We do not recommend you purchase your Replacement Property from a related person or business. We do not believe the Internal Revenue Service favors this type of exchange, even if the Exchangor, Entity-person, partnership, or corporation that accomplishes a tax-deferred exchange uses an Accommodator.
You should use the California Association of REALTORS® Form SES-11 to indicate your intent to sell your Relinquished Property and Form BES-11 to indicate your intent to buy your Replacement Property.
You should use Internal Revenue Service Form 8824, “Like-Kind Exchanges,” to report your tax-deferred exchange when you sold the Relinquished Property.
If you complete California Form 593, “Real Estate Withholding Certificate for Individual and Non-Individual Sellers” and submit it to your Escrow Company, you will be exempt from the California Franchise Tax Board withholding procedures. The Escrow Company handling the Relinquished Property will no longer be liable for withholding California tax; however, you will be subject to withholding at 3-1/3 percent on any cash you receive from the Accommodator at the end of the exchange.
We are frequently asked whether a vacation home can be used in an exchange. Vacation homes may qualify for an exchange if the taxpayer’s use of the house is minimal and the property is rented to unrelated parties.
On February 15, 2008, the Internal Revenue Service issued Rev. Proc. 2008-16, which included more stringent guidelines for exchanges of vacation homes.
The Exchangor must own the Relinquished Property for 24 months immediately before the exchange.
In each of the 12 months before the exchange, the taxpayer must rent the Relinquished Property for 14 days or more, at a fair market rate.
The taxpayer’s personal use of the property cannot exceed the greater of 14 days or 10 percent of the days rented in either of the 12-month periods.
Furthermore, the Exchangor must own the Replacement Property for 24 months immediately after the exchange.
Each 12 months after the exchange, the taxpayer must rent the Replacement Property for 14 days or more, at a fair market rate.
The taxpayer’s personal use of the Replacement Property cannot exceed the greater of 14 days or 10 percent of the days rented in either of the 12 12-month periods.
In summary, Exchangor must own a vacation home for two years before and after the exchange. Additionally, the property must be rented for at least 14 days in each of the four years. These guidelines represent a more onerous requirement than expected when exchanging vacation homes.
The above information is provided for general information purposes only. You should discuss your actual individual property transaction with your current attorney, certified public accountant, or us.
We know you will have questions about your transaction and encourage you to contact us. We will be pleased to assist you.
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