When is a sale a sale? When does a deal really close? Is it when title transfer occurs? It’s not always that simple unfortunately. Title transfer is only one of the factors when determining whether a transaction is closed and a sale has been made. There have been tax cases in which title had transferred but the sale was not considered closed. The opposite is also true — a sale was considered closed before title had transferred. There are also a number of cases where the sale was considered closed but possession had never been transferred.
While a transaction qualifies as a sale or exchange if property is transferred in exchange for consideration, effectively, a sale occurs when the benefits and burdens of ownership transfer from buyer to seller. So, in addition to title transfer, the following factors are ones the courts have considered in determining whether a sale has in fact occurred.
- How the parties treat the transaction
- Which party pays the property taxes
- Which party bears the risk of loss or damages to the property
- Which party receives the profits from the operation and sale of the property
- Whether there is a fixed sales price
- The parties’ intent
- The extent of control the purchaser has over the property
- Which party is responsible to insure the property
- A right to improve/change the property without the seller’s consent
- Whether the purchaser assumes obligations of which the property is subject
- Whether right to possession is vested in the purchaser
- Side agreements and/or surrounding circumstances
So, why is the precise date a sale is considered a sale an important detail? Because there are a number of scenarios in which the timing of the deal closing could significantly impact the tax liability of the buyer or seller. With the wide ranges in tax rates (both in ordinary rates and in capital gains rates based on the taxpayer’s income level) and specific taxes that are only applicable at certain income levels (e.g., the net investment income tax under IRC Section 1411), the actual year of sale could result in significant tax savings or liabilities. For example, a taxpayer generally may plan to pay tax on capital gains at 15%, but if the sale closes during a year he has a substantial amount of additional income that puts him in a higher tax bracket, he could end up paying 20% on the capital gain plus 3.8% net investment income tax. That means approximately 10% of the sale proceeds would go toward taxes instead of into the seller’s pocket.
Another scenario in which the sale date becomes critical is in like-kind-exchange transactions. In a 1031 exchange, the seller has 45 days from the sale date to identify a replacement property and 180 days from the sale date to purchase a replacement. This is a tight time frame when trying to complete large real estate portfolio like-kind exchanges, and every day can make a difference. From the buyer’s standpoint, the sale date determines when the buyer can start depreciating the asset (assuming it is an asset subject to depreciation). If this is in a year in which the bonus depreciation provisions apply, this can become significant if trying to close the transaction by year-end.
Specific facts and circumstances will always dictate when a sale officially occurs, and there is no listing of safe harbors for a sale to be considered closed. But bringing your advisors into the process as early as possible can aid in careful transaction planning that will allow you to maximize any tax opportunities or mitigate tax liabilities.
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This communication is for information only, and any action should only be taken after a detailed review of the specific situation and appropriate consultation.
Notwithstanding that these materials do not constitute legal, accounting or other professional advice, as may be required by United States Treasury Regulations and IRS Circular 230, you should be advised that these materials are not intended or written to be used, and cannot be used by you or any other person, for the purpose of avoiding penalties that may be imposed under federal tax laws. No written statement contained in these materials may be used by any person to support the promotion or marketing of or to recommend any federal tax transaction(s) or matter(s) addressed in these materials, and any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor with respect to any such federal tax transaction matter.