By Jeff Sorg
Exchanging real estate is a specialized area of real estate that requires knowledge beyond that given in preparation for a real estate license. In the context of real estate transactions, an exchange will usually be an Internal Revenue Code (“IRC”) Section 1031 Tax Deferred Exchange. The tax deferred exchange involves the transfer of one property for another property – or part cash and part property – as opposed to an outright cash sale. Most exchanges will include commercial or investment property and seldom involve owner-occupied residential property. To qualify as a tax deferred exchange, the properties must be like-kind in nature. Properties are of like-kind if they are of the same type. Generally, when real property held for investment is exchanged for real property to be held for investment, and if the exchange is done properly, there is no gain or loss recognized under IRC (IRC) Section 1031.
Real estate exchanging requires added broker supervision and further training beyond pre-license training. To avoid undue liability, and in the best interest of their client, a licensee should advise their client to seek professional legal and tax advice when exchanging. A real estate license does not qualify an individual to give legal or tax advice.
A real estate licensee needs enough knowledge about exchanging to help make sure the exchange is one of equal value for equal value, which is the foundation necessary for balancing equities. Equity is the difference between what a property is worth and what the owner owes against it. This balancing of equities can be achieved by exchanging one property for another, one property for several properties, or one property for property and cash. Although the exchange allows for equity in the property to provide the down payment, cash is necessary to pay closing costs. As a result, no exchange will be cash free. The necessary cash may be generated from the transaction itself or it can be supplied out of pocket by the exchanging parties. While a transaction involving two properties owned free and clear may seem to be cash free, each property owner must provide the cash needed to close the transaction.
Exchanging property might be the desired method of property acquisition for any number reasons. An example may be a person who is cash poor wanting to acquire a newly constructed investment property by exchanging a currently owned older investment property. Whatever the motivation, or whether the transaction is a simple sale or complicated exchange, real estate licensees must have the knowledge to understand the goals of the exchange transaction in order to advise and represent their clients. When a licensee works with the exchanger’s accountant, attorney, and exchange intermediary to make certain the exchanger’s intent and timing meet state and federal tax code requirements, if a technical problem arises during the transaction or with the IRS after the transaction, the licensee is less likely to be judged liable and to be accused of offering expert advice beyond the scope of their real estate license.