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Examining the newest trends in like-kind exchanges.

The first step in the DTE is dissolving the company that holds title to the relinquished property. The result of this dissolution is the transfer of title to the relinquished property from a company to a tenancy in common, in which title to the property is held by the constituent owners of the company (shareholders, members or partners).

Once this has occurred, the taxpayer of the relinquished property is no longer a company. Ownership now resides in the former owners of the company with each person holding an undivided ownership interest in the subject property in the same proportion as that person held ownership in the company that previously owned the property.

The tenancy in common can now enter into a contract for the sale of the property.

At the closing of title, those tenants in common who wish to "cash out" will receive their proportionate share of the net sale proceeds and those persons who wish to effect an exchange will deposit their shares of the net sale proceeds with a Qualified Intermediary, who will hold the sale proceeds as a trustee until a replacement property can be identified, placed under contract and then purchased.

At the closing of the replacement property, the Qualified Intermediary will deliver the sale proceeds from the first transaction that it held in escrow for the benefit of the exchangor, to the seller of the property in the second transaction.

The general rules for this style of deferred exchange is that the Qualified Intermediary must be an independent disinterested party, the replacement property must be identified in writing within 45 days after the closing of the first transaction and the closing on the second transaction must occur within 180 days after the first transaction. (You should consult a legal or accounting professional to discuss the many regulations that modify the application of the general rules.)

It must be stressed that both the relinquished property and the replacement property must be held for investment purposes or for trade or business in order to comply with the requirements of the Internal Revenue Code.

In this regard, the Internal Revenue Service has taken the position that a concurrent dissolution of the company, transfer of ownership to the related tenancy in common and sale of the property to an unrelated purchaser means that the tenancy in common (the entity that must be the taxpayer in the first leg of the exchange) may have never held the property as an investment or for a business purpose.

If time allows, it is advisable to have the tenancy in common own the property for a long enough period so that it can collect a rent check from a tenant at the property or conduct some business activities in its own name at the property in order to document the investment, trade or business requirement.

Conversely, there have been at least two widely reviewed cases (footnote not provided) that have held that the nature of the property and the use to which it had been put by the predecessor company is sufficient to establish the property was properly held for investment purposes or for trade or business. It is worth noting that an individual constituent of a company holding title to the relinquished property may transfer his or her ownership interests during the dissolution process into a single shareholder Subchapter S corporations or a single member limited liability company.

While this technique will achieve the legal result of creating insulation from liability, the Internal Revenue Service will treat the new company as a disregarded entity for tax purposes, which is the equivalent of ownership in the name of the individual taxpayer.

The creation of the disregarded entity is of particular value in the replacement property transaction because a lender providing a mortgage on the replacement property is likely to require that title to the property be held in a single asset bankruptcy remote entity. In conclusion, the wide ownership of investment real estate, the "graying" of America and the need to find opportunities for the reduction of estate tax liability while also accommodating investors who need to turn hard assets into cash has resulted in new ways to satisfy the needs of co-investors with differing financial strategies. At the forefront of this emerging area of transactional real estate is the Dissolution-Style 1031 Exchange.

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Comment:Examining the newest trends in like-kind exchanges.(PROPERTY MANAGEMENT)
Author:Wolloch, Richard D.
Publication:Real Estate Weekly
Date:Feb 28, 2007
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