Identification requirement of replacement property in like-kind exchanges.

Generally, a taxpayer is required to recognize the full amount of any gain or loss on the sale or exchange of property. However, if a taxpayer enters into a like-kind exchange in which he exchanges one property held for business or investment for another such property, in most cases he is able to defer any gain or loss under Sec. 1031(a). The exchange need not be simultaneous; the transfer between the parties can take place at different times. However, there are certain time limits for qualification of the nonsimultaneous exchange. Among other requirements, the taxpayer must identify the replacement property within 45 days after the date of the transfer of the relinquished property and must acquire the replacement property by the earlier of (1) 180 days after the date the property was relinquished or (2) the due date for the taxpayer's return for the tax year in which the transfer of the relinquished property occurred. The IRS and the courts will scrutinize nonsimultaneous exchanges to ascertain that these time frames are met. Failure to meet these time frames can trigger full gain recognition in the year of the initial transfer, as was recently illustrated in Dobrich, TC Memo 1997-447.

In this case, D entered into an exchange agreement with C, an intermediary, for the transfer of certain real property owned by D. In August 1989, D sold the property to a third party, with the buyer paying the sales proceeds directly to C. D embarked on a thorough search for replacement property and eventually purchased two replacement properties within the 180-day required period, using the funds received from the sale held by C. Although fully cognizant of the 45-day identification requirement, D did not identify the two properties as the replacement properties within the 45-day period. In addition, not only did the taxpayer fall to timely identify the acquired properties as the replacement property, but within the 45-day period, the taxpayer was only vaguely aware of one of the two properties and had stated to a real estate broker that he had no interest in it. Accordingly, the Tax Court concluded that the taxpayer did not properly identify the two replacement properties under the requirements of Sec. 1031(a)(3)(A), and, therefore, the gain realized from the relinquishment of the original property had to be recognized.

Subsequent to the years at issue in the above case, the Service issued regulations under Sec. 1031 discussing how taxpayers are to meet the identification requirements of Sec. 1031(a)(3). To properly satisfy the identification requirement, taxpayers must identify replacement property in a written document signed by the taxpayer and sent or otherwise delivered before the end of the identification period to either (1) the person obligated to transfer the replacement property to the taxpayer or (2) any person involved in the exchange (e.g., a party, an intermediary, title company or escrow agent) other than the taxpayer or the taxpayer's agent. In addition, the replacement property must be unambiguously described in the written document or agreement. Real property is unambiguously described if it is described by legal description. Because of the strict time frames and other requirements, taxpayers and their advisers contemplating a deferred like-kind exchange should consider the use of a professional intermediary to assist in the transaction.