In addition to trimming personal property taxes, you may want to review your real estate or other large property holdings and consider what the likely tax consequences will be if you decide to sell the assets. In most cases, if you have a building or piece of land that has substantially appreciated in value, you'll face a huge tax bill when you sell.
One way to defer the taxes you owe is to use like-kind exchange. With this strategy, you exchange your property for some other property you want to acquire without recognizing current income tax. The term "like-kind" refers to the nature and character of the property. It means that undeveloped land can be exchanged for developed property--but you can't defer gains on intangible interests in property, such as partnerships or limited liability companies.
To accomplish an exchange, you'll need an intermediary to carry out the transaction and set up a trust to hold the money from the exchange. The individuals involved in the exchange never actually receive cash.
"With a like-kind exchange, you assign the property to the intermediary, who sells it to a third party. The intermediary will buy the property you want and transfer it to you," explains Maury Golbert, a tax manager and attorney with the New York City accounting firm David Berdon & Co. LLP. In most cases, you can locate an intermediary who will accomplish the exchange for a fee, he says. The fee varies according to the size of the transaction but usually starts at about $1,500.
A like-kind exchange works especially well for entrepreneurs who are looking to expand their operations, says Susan Jacksack, a tax attorney and small business analyst with CCH Inc., a Riverwoods, Illinois, provider of legal, tax and business information. For example, a business owner with a small office building who needs a larger one to accommodate company growth is a good candidate for this type of exchange. "With a like-kind exchange, owners can exchange their property and throw in some cash to receive a piece of property they want," Jacksack explains.
If you add cash to the exchange to obtain a more expensive piece of property or building, that amount is added to the tax basis or cost of the new property. This is especially beneficial from a tax standpoint: By increasing the basis in the new property, the owner ends up with a greater sum to depreciate, Jacksack points out.
If you're on the receiving end of the cash, however, you must recognize taxable income on the money received in the transaction. For example, in an exchange, you get property worth $900,000 and $100,000 in cash for a piece of property valued at $1 million. The tax basis is $100,000. Of the $900,000 gain realized on the sale of the property, you would have to recognize $100,000 as taxable.
There are also a number of technical requirements involved in like-kind exchanges, says Golbert. If you decide to use the like-kind exchange strategy, be sure to work with a tax expert who specializes in that area. For example, the IRS will crack down on efforts to refinance a piece of property before a like-kind exchange takes place. Taxpayers often try to do this so they can take cash out of the property before making the exchange. "The government doesn't approve of that and may assess tax on the money received," Golbert explains.
For the most part, like-kind transactions take some time to accomplish, especially when it comes to finding the property needed for the exchange to take place. Fortunately, the IRS has taken these factors into consideration. Under its regulations, an exchange doesn't have to take place simultaneously; it can be accomplished over a six-month period.
If you're in a position where a like-kind exchange would benefit your tax situation, take the time to consider it. Says Golbert: "This technique not only defers tax, but it can be one of the most economically effective ways to diversify and improve your holdings."
David Berdon & Co. LLP, (212) 832-0400
Grant Thornton LLP, (615) 242-6566, http://www.grantthornton.com