Our friends at McFerran & Burns, PS (www.mbs-law.com) have shared these tips regarding tax deferred exchanges.
Pulling Cash out of an Exchange
This is a common subject of questions when an Exchangor is selling a property with a large taxable gain. Sometimes it just makes sense to pull out “Boot” in an exchange. This is a term commonly used by the IRS or tax professionals to define taxable funds within an exchange.
Where does that silly name come from? It is not defined in the tax code, or in any court cases. There are several theories, like the ones that talk about the early West where in a swap of items, something might have been slipped into a boot (like tobacco, sugar, or money) to settle a discrepancy or sweeten the deal. My favorite though is when Congress was discussing the exchange process, a Senator from The South drawled, “Are you trying to tell me, you can do an exchange and pull out some cash to boot”.
Keep in mind that when you do pull cash out of an exchange, that amount becomes taxable but it does not necessarily ruin or disqualify the exchange.
Timing
The Qualified Intermediary can only release funds at certain times defined by the IRS:
The most common time would be as you are closing the sale. The escrow closer can be instructed to release certain funds during that initial closing process. Please know that once those funds have been released out of the exchange, they cannot be returned to the exchange account.
The next opportunity would be after the 45th day, if no properties have been identified. Of course not identifying any replacement properties means that the exchange has failed and all funds can be released on the 46th day or later.
The next opportunity would be after the 45th day and you have closed on all identified properties, then all remaining funds can be released. It is common for us to instruct the closer of the last transaction to release all remaining funds to the exchanger while funding that last purchase, as long as there are no other properties identified.
The final opportunity is after the 180 days of the exchange has passed.
No matter how often exchangors are reminded that they cannot pull their funds out at any time, they often request it. After all, isn’t it their money?
Other Examples of Boot
Boot is also created if there is debt paid off in the sale, and it is not replaced in the purchase. In other words, the mortgage is paid off in the sale, but there is no debt or cash added in the purchase to replace that. The IRS views debt relief the same value as cash in an exchange. Another common situation that can lead to boot in an exchange is when escrow includes the proration of rents and deposits on the Settlement Statement. Those are actually relating to the business operating on the property, not the purchase or sale of the real estate.
For more information
If you would like more information, be sure to contact us. We may help you get in contact with our friends at MBS if we can’t help.
Thanks to our friend, Kevin Hummel, CES, manager of MBS’s Tax Deferred Exchange Practice Group for sharing this information.