Tax issues

Multi-Asset Mastery

These tax-deferred exchanges require pre-planning and careful attention.

Of all the transactions in the tax-deferred exchange arena, multi-asset exchanges can be the most complicated and technical in nature. These transactions include personal property, which is not like-kind with real property. While many clients and investors are familiar with the benefits of taxdeferred exchanges, they may not realize that personal property can be a part of tax-deferred exchanges. Commercial real estate professionals who are aware of the ability to include different asset types in exchanges can offer their clients an approach to maximize the tax savings and best accomplish their investment objective.

What Is Like-Kind?

The definition for like-kind real property is very broad. Basically, any property held for investment is like-kind with any other kind of real property held for investment. Primary residences, inventory held primarily for sale, and personal-use second homes (although some tax professionals have a difference of opinion on this last category) are the few categories of property that don't qualify. Most other real property is considered investment property and is therefore considered like-kind.

Other Assets

Along with real estate, any form of depreciable, tangible personal property such as furniture, fixtures, and equipment used in a trade or business can be exchanged.

However, real property is not like-kind with personal property, and the like-kind standard for personal property is more restrictive than the standard for real estate. For personal property to be considered like-kind, it must be in the same general asset class as described in Revenue Procedure 87-56 or in the same product class as stated in the North American Industrial Classification Manual. For instance, a computer is not considered like-kind with the table on which it sets.

Certain real property transactions, such as hospitals, nursing homes, hotels, restaurants, and convenience stores, contain large amounts of personal property. Apartment complexes may own commercial vending machines or laundry room equipment that would be considered personal property. A cell tower is not like-kind with the land on which it is situated. In these examples, the personal property is not like-kind with the real property and should be set up as separate exchanges or matched up separately.

More complicated are the sales of certain businesses where the elements can include land and buildings as well as intangibles such as goodwill, non-compete clauses, and franchise fees. Goodwill does not qualify for exchange purposes and none of these assets are considered like-kind with each other, but franchise fees can qualify.

Maximizing Exchange Value

Given the above examples, the obvious first step is to sort out the variables of real and personal property. Then, to maximize the economic success of the exchange, commercial real estate professionals should conduct fact-finding interviews to determine the different values associated with each element of the property. For example, what is the value of the land and building? What is the value of the personal property? What is the current basis for these items? Are other elements ? such as goodwill ? involved in the transaction? Rarely do clients have this information immediately available. They should work with their real estate and tax professionals to determine these values and the current basis for each element.

A decision should be made to determine if the value of each component is going to be specifically stated in the sales contract. The Internal Revenue Service publishes an asset matching form that some tax professionals require their clients to sign at closing. If this is the case, then it is important for the brokers negotiating the contracts to understand in advance what values will best benefit their clients.

One way to establish these target values is to understand what type of replacement property your client plans to acquire.

By understanding the type of replacement property your client is trying to buy and breaking down the type of exchangeable assets that are like-kind, brokers can apply this information as an overlay to determine the most desirable target values for the relinquished property.

Multi-Asset Case Study

For instance, your client is selling a convenience store for $1,000,000. A purchaser makes an offer to buy the property for the full asking price and allocates $500,000 in value to the real estate, $300,000 to the furniture, fixtures, and equipment, and $200,000 to goodwill. Previously you determined that your client was not going to buy another convenience store but wanted to exchange into an $800,000 income-producing property to augment his retirement income. You have found comparable properties in the area that will support a $111,000 real estate value for your client's property.

After meeting with your client and getting input from his tax adviser, you counter with a real estate value of $111,000. Because neither goodwill nor FF&E will be like-kind with the replacement property, both will trigger tax. Goodwill is taxed at capital gains rates whereas recapture of depreciation for FF&E is at ordinary income rates. You have been authorized to suggest a $100,000 value for the FF&E and a $200,000 for the goodwill. Because the purchaser is anxious to buy the property, she agrees. These adjustments have saved your client tens of thousands of dollars because of the careful pre-planning and information gathering.

Needless to say, if clients are buying replacement property that is similar to the property they are selling, there will be matchups. For instance, if they are exchanging a hotel for another hospitality property, there is a good chance that many of the personal property components also will match up.

All of the above information is very valuable in negotiating on your client's behalf. Of course, values should be established with the help of the client's tax professional and need to be defensible as real world numbers.

While the sophistication of clients vary from deal to deal, many more understand the value of tax-deferred exchanges and may have applicable situations. By determining the type and value of personal property that may be included in the transaction, brokers can better define possible replacement parameters and structure transactions to help clients best accomplish their investment objectives.

Careful planning is mandatory for multi-asset exchange transactions. When not used, it can lead to very high and unnecessary tax consequences, even in an exchange. Even the most savvy commercial real estate specialists should advise clients to work with tax professionals and qualified exchange intermediaries to create successful multi-asset exchanges.

Ronald L. Raitz

Ronald L. Raitz, CCIM, is president of Real Estate Exchange Services in Marietta, Ga., and serves on the Federation of Exchange Accommodators board of directors. Contact him at (770) 579-1155, ext. 10, or [email protected] com.

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