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Business & Money

In a "like kind exchange" transaction, the IRS permits a seller to defer taxes on its inherent gain on assets being sold.
Fortnightly Magazine - April 15 2003

instance, it may be possible to exchange gas or electric distribution properties for oil and gas exploration properties, even where one is owned in fee and the other takes the form of exploration rights. Also, not all of the property acquired needs to be of like kind-a mixed property transaction does not disqualify the eligible portion, although it will provide less than complete tax deferral.

The second requirement is that the property involved on one side of the exchange must be transferred within 180 days of the closing date with respect to the offsetting property. This can be done in either order, i.e. property A is sold and then property B is acquired within 180 days, or vice versa. Normally it is advisable to have both sides of the exchange at least identified, and either up for auction or other method of disposition, and under contract if possible, so that the safe harbor period is assured.

In regulated asset situations, the timing can be an element that needs special planning. The good news is that the 180-day period only runs from the date of closing of the first leg of the transaction. The offset to that is that it can be difficult to get buyers and sellers in unrelated portions of transactions to agree to put their business timetable at the mercy of another deal, which means nothing to them.

At the end of the day, the several transactions we are aware of that have been consummated did not experience any insuperable difficulty on this point. In addition, the dramatic improvement in the economics of a given transaction that can be obtained by using the LKE method can often provide for some level of "sweetener" to help the counterparties bide their time.

The third requirement under the Internal Revenue Code to qualify for LKE treatment is that, if the first leg is completed and the property that is to be substituted is not already known, the seller must identify the exchange property within 45 days of the first closing date. This time period is subsumed within the 180-day period to get both portions closed as mentioned above, and is unlikely to be relevant to planners working on utility timetables.

Finding the Right Transaction Conditions

Several elements are critical to achieving optimal results in connection with LKE transactions. First, non-core low basis assets are the best acquisition currency. Alternatively, a sale-leaseback transaction relating to headquarters buildings, R&D facilities, or other similar real-estate assets (including the type of oil and gas E&P assets that float around on many utility balance sheets) can be matched up with the acquisition of income-producing properties of many different varieties.

Because planning is critical, one key element is to provide adequate time for the market to be explored. A distress sale atmosphere needs to be avoided, which is the reason the two elements of the transaction should be decoupled as much as possible. As discussed above, this helps avoid being whipsawed between Buyer B and Seller A and helps obtain optimum pricing on both sides of the transaction.