Alternative Tax Deferral Methods to Traditional Section 1031 Like-kind Exchange Plans
My August column discussed three alternative tax deferral methods to the traditional Section 1031 like-kind exchange plan. When like-kind replacement property is properly identified within 45 days, and the acquisition is completed within 180 days of the sale of the replaced property, all is fine and the tax deferral achieved.
However, well-designed like-kind exchange tax deferral plans can fail due to non-controllable factors. For example, the regulations provide no freedom to extend the mandated 45-day and 180-day requirements, so when a problem arises, the taxpayer encounters and endures a strain to complete an acquisition that might turn out to have been ill advised and improperly rushed. If these deadlines are missed, even when it is not your fault, the tax deferral under Section 1031 can be completely lost.
Another way to plan for the Section 1031 like-kind tax deferred exchange – while protecting against a possible failure to complete a qualified replacement – is to incorporate an optional Section 1031 “backup rescue plan.” The plan is designed to convert an intended exchange into a qualified tax deferred structured installment sale, as an alternative deferral method. The IRS regulations specifically recognize that these two deferral methods can be used in a coordinated fashion, whether it is part exchange and part installment sale, or all of either.
With a 1031 backup rescue plan, should the potential for failure to complete all the qualifying steps occur at a late date, the initial sale transaction converts its nature and qualifies as an installment sale that defers the gain over predetermined installment terms – still securing all the desired tax deferrals.
If you expect your 1031 exchange to be just a partial replacement, the gain on the balance can be deferred by taking an installment note for the shortfall. With a Section 453 installment gain deferral, you have no time limits or qualifying property requirements to meet; you merely need to have payments due in any of the following years.
Several methods might be deployed to overcome 1031 exchange limitations. The first option is to find a party to buyout the Qualified Intermediary (QI) on installment terms to your liking. This approach is based on the QI being treated as the party that accepts the exchangor’s disposition property with the intent to provide replacement property. If the QI sells for an installment note, when the exchange fails, the QI will give the exchangor an installment sale note, as shown under Regulation section 1.1031(j)(2), example 3.
A second salvage option to consider is to enlist the QI and the original buyer to reform their terms of purchase into an installment purchase, using the QI deposited money as col- lateral in support of the installment note to seller. All this must be coordinated with the QI prior to any receipt of property or cash by the seller.
Solving these issues is the business activity of Installment Accommodators (IA) that offer installment purchase terms and provide key features, such as independent collateral and credit to fully secure the entire installment obligation, thereby eliminating the need to worry over the credit worthiness of ultimate buyers. This way negates the need for a lien on the property sold and is a method employed by one firm as shown in their website at www.scrowcollateral.com. Other similar firms can be found with a web search.
Back up safety features may appear to be wasted effort, but these insurance features will save the day when the need arises. A backup rescuer plan assures you will produce a tax deferral result.
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