Category: 1031 Exchange General

Since 1921, the rules for qualifying and completing 1031 exchanges have gradually broadened and become less restrictive. Even so, there are do’s and don’ts as well as several gray areas of which taxpayers should be aware. The topics below could each be the subject of their own post. They are raised here to draw your attention, and to invite further discussion with your advisors, and the team at Accruit.
Holding periods
There are no standard or specific holding periods by which a taxpayer must abide for property to meet the definition of “like kind” or held for investment or business use (the only exception is Related Parties, discussed below). Holding periods are, therefore, determined on a case-by-case basis regarding the taxpayer’s genuine intentions based in part on: (i) their reasons for acquiring, holding, and disposing of the property; (ii) the taxpayer’s primary occupation; (iii) previous 1031 exchange activity; and (iv) use of property. Generally, the longer the holding period the better. However, a taxpayer who is disqualified from utilizing the benefits of Section 1031 would not then qualify merely because of a long holding period. What the Code, the courts, and the IRS want to prevent is taxpayers holding property primarily for sale and attempting to defer their taxes utilizing Section 1031 (e.g., a builder of residential subdivisions).
Related parties
The current rules are complex and restrictive, and all potential related party exchangers are encouraged to seek the guidance of their tax and legal counsel. Selling a relinquished property to a related party as part of an exchange transaction may be acceptable, provided the related party holds the property for a mandatory 24-month holding period. Acquiring a replacement property from a related party with exchange funds may also be acceptable, if the related party does their own 1031 exchange and holds their replacement property for two years and does not “cash out” of that property. (https://www.buzzsprout.com/270590/5561182″>Listen to Max Hansen discuss the intricacies of related party issues)
Different entities
Generally, to qualify for Section 1031 the same entity that transferred the relinquished property must acquire the replacement property. For example, if the old property is being sold by an LLC, the new property should be acquired by the same LLC. It clearly should not be acquired by another entity, which would be a completely different taxpayer. There are some limited exceptions in the event an LLC is a single-member LLC, and the new property is being acquired by a new LLC with the same single member as the former LLC.
A similar issue arises when spouses are involved in an exchange transaction. For example, if the old property is owned solely by Husband, the new property should not be acquired by Husband and Wife. Conversely, if the old property is owned by Husband and Wife, the new property should be acquired in the same fashion. There are some very narrow exceptions to these rules, which go beyond the scope of this newsletter.
Already owned property
The “like kind” requirement will not have been met if the taxpayer attempts to transfer any exchange value from the relinquished property into property the taxpayer already owns. For example, the taxpayer cannot reinvest the proceeds from the sale of a relinquished property into upgrades at taxpayer’s other property. Further, the proceeds from the relinquished property may not be used to pay down existing debt on taxpayer’s other property.
Refinance
It is generally accepted that the taxpayer can receive equity from the replacement property through the placement of a new loan (refinance). However, the taxpayer must not refinance the old or relinquished property “in anticipation” of an exchange by placing a loan on the relinquished property once the taxpayer has taken steps to dispose of such property unless the taxpayer: 1) uses those proceeds to acquire or improve the replacement property, and 2) has no actual or constructive receipt of such proceeds. It generally helps is there is a bona fide business reason for any refinance within the parameters of an exchange transaction.
Dissolution of a partnership
The Code is clear – partnership interests do not qualify for Section 1031 tax deferral. Yet taxpayers’ advisors routinely recommend the following strategy:

Dissolve partnership.
Create new entity (tenancy-in-common).
Distribute pro-rata share to individuals (previously partners).
Exchange individual tenancy-in-common interests at will.

Two fundamental problems arise from this advice:
1. The Code requires that property must be “held for productive use in a trade or business or investment.” This implies there must be a holding period, for tenancy in common interests distributed out of a partnership although, as discussed above, the holding period requirement is uncertain. (Read more on the release of exchange funds)

Conclusion
If any of these issues is or may be present in your 1031 exchange, it is strongly recommended that you discuss them with your tax and legal advisors, and your qualified intermediary, as soon as possible. Accruit’s leadership team has over 170 years of combined experience in working with taxpayers and their advisors in structuring successful 1031 exchanges.
At Accruit, we handle all types of complex exchanges. Have a situation you’d like to speak to an expert about? No problem. We’re happy to have a free, no-obligation consultation with you.

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Since 1921, the rules for qualifying and completing 1031 exchanges have gradually broadened and become less restrictive. Even so, there are do’s and don’ts as well as several gray areas of which taxpayers should be aware. The topics below could each be the subject of their own post. They are raised here to draw your attention, and to invite further discussion with your advisors, and the team at Accruit.
Holding periods
There are no standard or specific holding periods by which a taxpayer must abide for property to meet the definition of “like kind” or held for investment or business use (the only exception is Related Parties, discussed below). Holding periods are, therefore, determined on a case-by-case basis regarding the taxpayer’s genuine intentions based in part on: (i) their reasons for acquiring, holding, and disposing of the property; (ii) the taxpayer’s primary occupation; (iii) previous 1031 exchange activity; and (iv) use of property. Generally, the longer the holding period the better. However, a taxpayer who is disqualified from utilizing the benefits of Section 1031 would not then qualify merely because of a long holding period. What the Code, the courts, and the IRS want to prevent is taxpayers holding property primarily for sale and attempting to defer their taxes utilizing Section 1031 (e.g., a builder of residential subdivisions).
Related parties
The current rules are complex and restrictive, and all potential related party exchangers are encouraged to seek the guidance of their tax and legal counsel. Selling a relinquished property to a related party as part of an exchange transaction may be acceptable, provided the related party holds the property for a mandatory 24-month holding period. Acquiring a replacement property from a related party with exchange funds may also be acceptable, if the related party does their own 1031 exchange and holds their replacement property for two years and does not “cash out” of that property. (https://www.buzzsprout.com/270590/5561182″>Listen to Max Hansen discuss the intricacies of related party issues)
Different entities
Generally, to qualify for Section 1031 the same entity that transferred the relinquished property must acquire the replacement property. For example, if the old property is being sold by an LLC, the new property should be acquired by the same LLC. It clearly should not be acquired by another entity, which would be a completely different taxpayer. There are some limited exceptions in the event an LLC is a single-member LLC, and the new property is being acquired by a new LLC with the same single member as the former LLC.
A similar issue arises when spouses are involved in an exchange transaction. For example, if the old property is owned solely by Husband, the new property should not be acquired by Husband and Wife. Conversely, if the old property is owned by Husband and Wife, the new property should be acquired in the same fashion. There are some very narrow exceptions to these rules, which go beyond the scope of this newsletter.
Already owned property
The “like kind” requirement will not have been met if the taxpayer attempts to transfer any exchange value from the relinquished property into property the taxpayer already owns. For example, the taxpayer cannot reinvest the proceeds from the sale of a relinquished property into upgrades at taxpayer’s other property. Further, the proceeds from the relinquished property may not be used to pay down existing debt on taxpayer’s other property.
Refinance
It is generally accepted that the taxpayer can receive equity from the replacement property through the placement of a new loan (refinance). However, the taxpayer must not refinance the old or relinquished property “in anticipation” of an exchange by placing a loan on the relinquished property once the taxpayer has taken steps to dispose of such property unless the taxpayer: 1) uses those proceeds to acquire or improve the replacement property, and 2) has no actual or constructive receipt of such proceeds. It generally helps is there is a bona fide business reason for any refinance within the parameters of an exchange transaction.
Dissolution of a partnership
The Code is clear – partnership interests do not qualify for Section 1031 tax deferral. Yet taxpayers’ advisors routinely recommend the following strategy:

Dissolve partnership.
Create new entity (tenancy-in-common).
Distribute pro-rata share to individuals (previously partners).
Exchange individual tenancy-in-common interests at will.

Two fundamental problems arise from this advice:
1. The Code requires that property must be “held for productive use in a trade or business or investment.” This implies there must be a holding period, for tenancy in common interests distributed out of a partnership although, as discussed above, the holding period requirement is uncertain. (Read more on the release of exchange funds)

Conclusion
If any of these issues is or may be present in your 1031 exchange, it is strongly recommended that you discuss them with your tax and legal advisors, and your qualified intermediary, as soon as possible. Accruit’s leadership team has over 170 years of combined experience in working with taxpayers and their advisors in structuring successful 1031 exchanges.
At Accruit, we handle all types of complex exchanges. Have a situation you’d like to speak to an expert about? No problem. We’re happy to have a free, no-obligation consultation with you.

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Sales of wind farms and turbines is becoming increasingly common and could become more so as renewable energy continues to grow as a part of the U.S. energy infrastructure. Wind farms are a source of renewable energy found around the world, and we can expect to see this industry expand here in the States. The sale of a renewable energy asset such as a wind farm or turbine may be from one taxpayer to another, or to a company who is in the business of aggregating these assets for its own business of acquiring, owning, and leasing such assets. The value of the wind farm or turbine is largely a function of the value of the lease, i.e. the rent/royalties, term, and strength of the lessee. Oftentimes the sale prices can be considerable, which in turn, may cause a significant tax event to the seller. In many instances, the availability of a tax deferred exchange under Section 1031 of the Internal Revenue Code can be the key to enabling a sale to take place by minimizing the tax burden to the seller.
Use of Easement for Sale
As many people know, One particular Private Letter Ruling provides validation of such a structure for the exchange of a cell tower easement. Although a Private Letter Ruling is “private” and can only be relied on by the recipient, the IRS does publish them to let the public know its position on the subject of the ruling.
Facts of the Private Letter Ruling
Facts of the PLR included a proposed “exclusive easement” for the site of the cell phone tower and “non-exclusive easements” for road access to the tower, maintenance, and access to the rooftop. Transfer of the easement also included an assignment of the lease from the taxpayer to the easement owner. PLR references that most easements are perpetual unless the easement owner abandons the site for a number or years. It also states that a small number of easements are long term but not perpetual in duration.
This PLR provides a roadmap to structing an easement sale which includes the transfer of the lease of the cell tower or billboard located on the easement. It is important to note that the ruling references perpetual and long-term easements. That raises the question whether any wind farm or turbine sale requires a perpetual easement. In the PLR, the easement was to cease if the easement owner abandoned the property. That would seem to affect its otherwise perpetual nature. In addition, in the Analysis section of the PLR, the Service specifically noted that the “Taxpayer will acquire, own and lease perpetual and long-term easements…” [emphasis added]. In the Conclusion section of the PLR the Service states that “an easement acquired by Taxpayer under and Easement Agreement is an “interest in real property” that qualifies, under § 856(c)(5(B), as a real estate asset…”. There is no reference in the conclusion indicating that the long-term easement would be treated differently than a permanent easement.
Summary
There is an active market in the sale of wind farms and turbines. Similar renewable energy assets such as solar farms and arrays should be capable of being exchanged in the same manner as wind farms and turbines. While some of these assets are valued based upon the value of the lease associated with the asset, an owner’s interest in a lease cannot be the subject of a 1031 exchange. Private Letter Ruling 1149003 provides some guidance on how to structure the transfer of the lease value by selling the easement under the leased asset. To maximize the validity of the easement, it would be best if the easement were perpetual in nature. However, it may be possible to do the exchange that is long term in nature.
As always, it is always advisable to consult with professional tax or legal advisors before proceeding with such a transaction. Accruit has facilitated many of these types transactions over the years and is available to assist as the Qualified Intermediary.

Sales of wind farms and turbines is becoming increasingly common and could become more so as renewable energy continues to grow as a part of the U.S. energy infrastructure. Wind farms are a source of renewable energy found around the world, and we can expect to see this industry expand here in the States. The sale of a renewable energy asset such as a wind farm or turbine may be from one taxpayer to another, or to a company who is in the business of aggregating these assets for its own business of acquiring, owning, and leasing such assets. The value of the wind farm or turbine is largely a function of the value of the lease, i.e. the rent/royalties, term, and strength of the lessee. Oftentimes the sale prices can be considerable, which in turn, may cause a significant tax event to the seller. In many instances, the availability of a tax deferred exchange under Section 1031 of the Internal Revenue Code can be the key to enabling a sale to take place by minimizing the tax burden to the seller.
Use of Easement for Sale
As many people know, One particular Private Letter Ruling provides validation of such a structure for the exchange of a cell tower easement. Although a Private Letter Ruling is “private” and can only be relied on by the recipient, the IRS does publish them to let the public know its position on the subject of the ruling.
Facts of the Private Letter Ruling
Facts of the PLR included a proposed “exclusive easement” for the site of the cell phone tower and “non-exclusive easements” for road access to the tower, maintenance, and access to the rooftop. Transfer of the easement also included an assignment of the lease from the taxpayer to the easement owner. PLR references that most easements are perpetual unless the easement owner abandons the site for a number or years. It also states that a small number of easements are long term but not perpetual in duration.
This PLR provides a roadmap to structing an easement sale which includes the transfer of the lease of the cell tower or billboard located on the easement. It is important to note that the ruling references perpetual and long-term easements. That raises the question whether any wind farm or turbine sale requires a perpetual easement. In the PLR, the easement was to cease if the easement owner abandoned the property. That would seem to affect its otherwise perpetual nature. In addition, in the Analysis section of the PLR, the Service specifically noted that the “Taxpayer will acquire, own and lease perpetual and long-term easements…” [emphasis added]. In the Conclusion section of the PLR the Service states that “an easement acquired by Taxpayer under and Easement Agreement is an “interest in real property” that qualifies, under § 856(c)(5(B), as a real estate asset…”. There is no reference in the conclusion indicating that the long-term easement would be treated differently than a permanent easement.
Summary
There is an active market in the sale of wind farms and turbines. Similar renewable energy assets such as solar farms and arrays should be capable of being exchanged in the same manner as wind farms and turbines. While some of these assets are valued based upon the value of the lease associated with the asset, an owner’s interest in a lease cannot be the subject of a 1031 exchange. Private Letter Ruling 1149003 provides some guidance on how to structure the transfer of the lease value by selling the easement under the leased asset. To maximize the validity of the easement, it would be best if the easement were perpetual in nature. However, it may be possible to do the exchange that is long term in nature.
As always, it is always advisable to consult with professional tax or legal advisors before proceeding with such a transaction. Accruit has facilitated many of these types transactions over the years and is available to assist as the Qualified Intermediary.

Sales of wind farms and turbines is becoming increasingly common and could become more so as renewable energy continues to grow as a part of the U.S. energy infrastructure. Wind farms are a source of renewable energy found around the world, and we can expect to see this industry expand here in the States. The sale of a renewable energy asset such as a wind farm or turbine may be from one taxpayer to another, or to a company who is in the business of aggregating these assets for its own business of acquiring, owning, and leasing such assets. The value of the wind farm or turbine is largely a function of the value of the lease, i.e. the rent/royalties, term, and strength of the lessee. Oftentimes the sale prices can be considerable, which in turn, may cause a significant tax event to the seller. In many instances, the availability of a tax deferred exchange under Section 1031 of the Internal Revenue Code can be the key to enabling a sale to take place by minimizing the tax burden to the seller.
Use of Easement for Sale
As many people know, One particular Private Letter Ruling provides validation of such a structure for the exchange of a cell tower easement. Although a Private Letter Ruling is “private” and can only be relied on by the recipient, the IRS does publish them to let the public know its position on the subject of the ruling.
Facts of the Private Letter Ruling
Facts of the PLR included a proposed “exclusive easement” for the site of the cell phone tower and “non-exclusive easements” for road access to the tower, maintenance, and access to the rooftop. Transfer of the easement also included an assignment of the lease from the taxpayer to the easement owner. PLR references that most easements are perpetual unless the easement owner abandons the site for a number or years. It also states that a small number of easements are long term but not perpetual in duration.
This PLR provides a roadmap to structing an easement sale which includes the transfer of the lease of the cell tower or billboard located on the easement. It is important to note that the ruling references perpetual and long-term easements. That raises the question whether any wind farm or turbine sale requires a perpetual easement. In the PLR, the easement was to cease if the easement owner abandoned the property. That would seem to affect its otherwise perpetual nature. In addition, in the Analysis section of the PLR, the Service specifically noted that the “Taxpayer will acquire, own and lease perpetual and long-term easements…” [emphasis added]. In the Conclusion section of the PLR the Service states that “an easement acquired by Taxpayer under and Easement Agreement is an “interest in real property” that qualifies, under § 856(c)(5(B), as a real estate asset…”. There is no reference in the conclusion indicating that the long-term easement would be treated differently than a permanent easement.
Summary
There is an active market in the sale of wind farms and turbines. Similar renewable energy assets such as solar farms and arrays should be capable of being exchanged in the same manner as wind farms and turbines. While some of these assets are valued based upon the value of the lease associated with the asset, an owner’s interest in a lease cannot be the subject of a 1031 exchange. Private Letter Ruling 1149003 provides some guidance on how to structure the transfer of the lease value by selling the easement under the leased asset. To maximize the validity of the easement, it would be best if the easement were perpetual in nature. However, it may be possible to do the exchange that is long term in nature.
As always, it is always advisable to consult with professional tax or legal advisors before proceeding with such a transaction. Accruit has facilitated many of these types transactions over the years and is available to assist as the Qualified Intermediary.

Many investors are aware of 1031 exchanges and their usefulness in their real estate portfolios. These investors use a 1031 exchange to reposition their investments to other neighborhoods, or other states, or to redistribute their investments to different asset classes. However, many investors overlook the value of a 1031 exchange as an estate planning tool.
The Situation
Mr. Spencer currently owns a mixed-use building on a prime downtown corner in a small town in central New Jersey. There are 21 office spaces, four apartments, and off-street parking. Mr. Spencer’s current estate plan would have this property pass to his four grandchildren upon his death.
The Problem
Mr. Spencer’s new estate planning attorney has pointed out that if each grandchild inherits 25% of the same property, they may not be able to agree on what to do with the property when they inherit it. The attorney suggests that one may wish to sell the property to receive the cash windfall; another may wish to refinance it so they can make upgrades to it and increase the rent; the third may want to refinance it so that they can use the cash in other ways; and perhaps the fourth grandchild is a little Bohemian and cannot decide what he wants to do. At the same time, Mr. Spencer does not want to sell the property outright and pay hefty capital gains and depreciation recapture taxes.
Let’s assume Mr. Spencer acquired the property 20 years ago for $250,000 and has made $50,000 in improvements during that time and took approximately $125,000 in depreciation, resulting in an adjusted basis of $175,000. It is anticipated that the sale price of the existing property will be $850,000. Without a 1031 exchange, Mr. Spencer would be expecting to pay taxes as follows:

20% capital gains on the appreciation
($675,000 x 20%)
$13,500

25% recapture on depreciation taken
($125,000 x 25%)
$31,250

Affordable Care Act tax
($675,000 x 3.8%)
$25,650

NJ State capital gains on the appreciation
($675,000 x 8.97%)
$60,547

NJ State depreciation recapture
($125,000 x 8.97%)
$11,212

Total tax paid
 
$142,159

 
 
The Solution: 1031 Exchange
Mr. Spencer will structure the sale of the existing mixed-use property as part of a Section 1031 tax-deferred exchange. He has determined that he will trade equal or up in value and maintain a mortgage of at least the same value as on the mixed-use property, to fully benefit from Section 1031.
Upon the sale of the mixed-use property, the exchange proceeds were sent directly to Mr. Spencer’s qualified intermediary (“QI”) to be held in escrow until the purchase of his replacement properties.
Within 45 days after the closing on the sale, Mr. Spencer properly identified four identical condos in one condo complex, conveniently located less than a mile from the local university. Each condo will be acquired for $249,000, with a gross acquisition value of $996,000—which is greater than the sale price of his relinquished property. Closings for the four condos all occurred within 180 days of the sale of the relinquished property, utilizing the exchange proceeds held by the QI and additional mortgage financing.
Thereafter, Mr. Spencer revised his Will to direct that each grandchild would inherit their own condo.
The Result
Mr. Spencer has successfully completed a 1031 exchange from one relinquished property into four replacement properties. He exchanged equal or up in value, equal or up in equity, and equal or up in mortgage value, fully deferring the $142,159 in anticipated taxes. Upon Mr. Spencer’s eventual death, the grandchildren will inherit the condos at the fair market value as of the date of his death, receiving a step-up in the basis. The depreciation recapture and capital gains taxes will have been completely avoided.

Many investors are aware of 1031 exchanges and their usefulness in their real estate portfolios. These investors use a 1031 exchange to reposition their investments to other neighborhoods, or other states, or to redistribute their investments to different asset classes. However, many investors overlook the value of a 1031 exchange as an estate planning tool.
The Situation
Mr. Spencer currently owns a mixed-use building on a prime downtown corner in a small town in central New Jersey. There are 21 office spaces, four apartments, and off-street parking. Mr. Spencer’s current estate plan would have this property pass to his four grandchildren upon his death.
The Problem
Mr. Spencer’s new estate planning attorney has pointed out that if each grandchild inherits 25% of the same property, they may not be able to agree on what to do with the property when they inherit it. The attorney suggests that one may wish to sell the property to receive the cash windfall; another may wish to refinance it so they can make upgrades to it and increase the rent; the third may want to refinance it so that they can use the cash in other ways; and perhaps the fourth grandchild is a little Bohemian and cannot decide what he wants to do. At the same time, Mr. Spencer does not want to sell the property outright and pay hefty capital gains and depreciation recapture taxes.
Let’s assume Mr. Spencer acquired the property 20 years ago for $250,000 and has made $50,000 in improvements during that time and took approximately $125,000 in depreciation, resulting in an adjusted basis of $175,000. It is anticipated that the sale price of the existing property will be $850,000. Without a 1031 exchange, Mr. Spencer would be expecting to pay taxes as follows:

20% capital gains on the appreciation
($675,000 x 20%)
$13,500

25% recapture on depreciation taken
($125,000 x 25%)
$31,250

Affordable Care Act tax
($675,000 x 3.8%)
$25,650

NJ State capital gains on the appreciation
($675,000 x 8.97%)
$60,547

NJ State depreciation recapture
($125,000 x 8.97%)
$11,212

Total tax paid
 
$142,159

 
 
The Solution: 1031 Exchange
Mr. Spencer will structure the sale of the existing mixed-use property as part of a Section 1031 tax-deferred exchange. He has determined that he will trade equal or up in value and maintain a mortgage of at least the same value as on the mixed-use property, to fully benefit from Section 1031.
Upon the sale of the mixed-use property, the exchange proceeds were sent directly to Mr. Spencer’s qualified intermediary (“QI”) to be held in escrow until the purchase of his replacement properties.
Within 45 days after the closing on the sale, Mr. Spencer properly identified four identical condos in one condo complex, conveniently located less than a mile from the local university. Each condo will be acquired for $249,000, with a gross acquisition value of $996,000—which is greater than the sale price of his relinquished property. Closings for the four condos all occurred within 180 days of the sale of the relinquished property, utilizing the exchange proceeds held by the QI and additional mortgage financing.
Thereafter, Mr. Spencer revised his Will to direct that each grandchild would inherit their own condo.
The Result
Mr. Spencer has successfully completed a 1031 exchange from one relinquished property into four replacement properties. He exchanged equal or up in value, equal or up in equity, and equal or up in mortgage value, fully deferring the $142,159 in anticipated taxes. Upon Mr. Spencer’s eventual death, the grandchildren will inherit the condos at the fair market value as of the date of his death, receiving a step-up in the basis. The depreciation recapture and capital gains taxes will have been completely avoided.

Many investors are aware of 1031 exchanges and their usefulness in their real estate portfolios. These investors use a 1031 exchange to reposition their investments to other neighborhoods, or other states, or to redistribute their investments to different asset classes. However, many investors overlook the value of a 1031 exchange as an estate planning tool.
The Situation
Mr. Spencer currently owns a mixed-use building on a prime downtown corner in a small town in central New Jersey. There are 21 office spaces, four apartments, and off-street parking. Mr. Spencer’s current estate plan would have this property pass to his four grandchildren upon his death.
The Problem
Mr. Spencer’s new estate planning attorney has pointed out that if each grandchild inherits 25% of the same property, they may not be able to agree on what to do with the property when they inherit it. The attorney suggests that one may wish to sell the property to receive the cash windfall; another may wish to refinance it so they can make upgrades to it and increase the rent; the third may want to refinance it so that they can use the cash in other ways; and perhaps the fourth grandchild is a little Bohemian and cannot decide what he wants to do. At the same time, Mr. Spencer does not want to sell the property outright and pay hefty capital gains and depreciation recapture taxes.
Let’s assume Mr. Spencer acquired the property 20 years ago for $250,000 and has made $50,000 in improvements during that time and took approximately $125,000 in depreciation, resulting in an adjusted basis of $175,000. It is anticipated that the sale price of the existing property will be $850,000. Without a 1031 exchange, Mr. Spencer would be expecting to pay taxes as follows:

20% capital gains on the appreciation
($675,000 x 20%)
$13,500

25% recapture on depreciation taken
($125,000 x 25%)
$31,250

Affordable Care Act tax
($675,000 x 3.8%)
$25,650

NJ State capital gains on the appreciation
($675,000 x 8.97%)
$60,547

NJ State depreciation recapture
($125,000 x 8.97%)
$11,212

Total tax paid
 
$142,159

 
 
The Solution: 1031 Exchange
Mr. Spencer will structure the sale of the existing mixed-use property as part of a Section 1031 tax-deferred exchange. He has determined that he will trade equal or up in value and maintain a mortgage of at least the same value as on the mixed-use property, to fully benefit from Section 1031.
Upon the sale of the mixed-use property, the exchange proceeds were sent directly to Mr. Spencer’s qualified intermediary (“QI”) to be held in escrow until the purchase of his replacement properties.
Within 45 days after the closing on the sale, Mr. Spencer properly identified four identical condos in one condo complex, conveniently located less than a mile from the local university. Each condo will be acquired for $249,000, with a gross acquisition value of $996,000—which is greater than the sale price of his relinquished property. Closings for the four condos all occurred within 180 days of the sale of the relinquished property, utilizing the exchange proceeds held by the QI and additional mortgage financing.
Thereafter, Mr. Spencer revised his Will to direct that each grandchild would inherit their own condo.
The Result
Mr. Spencer has successfully completed a 1031 exchange from one relinquished property into four replacement properties. He exchanged equal or up in value, equal or up in equity, and equal or up in mortgage value, fully deferring the $142,159 in anticipated taxes. Upon Mr. Spencer’s eventual death, the grandchildren will inherit the condos at the fair market value as of the date of his death, receiving a step-up in the basis. The depreciation recapture and capital gains taxes will have been completely avoided.

Can Franchise Rights be Exchanged?
Since becoming law in 1921, the rationale for the inclusion of tax deferred exchanges in the IRS code, has been that a taxpayer who is vested with an asset and who receives in exchange other like-kind assets, and no cash, there is a continuity of holding the same or similar assets. Since the same kind of assets were sold and bought and the taxpayer pocketed no cash, the transaction isn’t seen as a taxable event. The gain on the sale of the first assets, the relinquished property , is deferred until the acquired like-kind assets, the replacement property , are sold without a further exchange.
Upon the passage of the Tax Cuts and Jobs Act (TCJA) in 2017, the types of assets qualifying for tax deferral through an exchange changed dramatically. Tax deferral through 1031 exchanges would only be allowed for what is considered real property (land, buildings, etc.) and not for personal property (heavy equipment, cars, franchises. Therefore, since the passage of the TCJA, the actual franchise rights no longer qualify for a like kind exchange to defer taxes on gains. However, should the investor own the underlying real property where the Franchise resides the investor still could qualify for an exchange on the underlying land/building.
What Qualifies for Tax Deferral upon the Sale of a Franchise?
Perhaps the most common inquiries around franchise exchanges are those that involve fast food restaurants. An owner might have one or more franchise locations that have greatly increased in value over time, value that the owner would like to parlay into additional restaurants. The exchange of such a business was formerly a more straightforward matter because the IRS regarded the business as a whole entity that included the value of any underlying assets. This changed shortly before 1991’s exchange regulations, and now the IRS requires that each underlying asset be separated and valued individually.
For owners/investors of franchises this means that the value of the franchise rights are separate from the value of land, buildings and furniture, fixtures and equipment (FF&E). A restaurant franchise valued at $300,000 for the franchise rights and $750,000 for the land/building can separate the sale of the land/building from the sale of the franchise rights. The land/building would then qualify for a like-kind exchange into land/building for a new franchise or a multitude of other real property deemed like-kind such as a multi-family rental building or farmland.
It’s worth noting that any value associated with goodwill, including trademarks and trade names, is not capable of being exchanged, because the regulations state that goodwill is “inherently unique and inseparable from the business.” For this reason, sellers of businesses may wish to minimize the value of the goodwill and increase another component asset of the sale which will be capable of receiving like-kind exchange treatment. Inventory and cash-on-hand are also not part of a franchise exchange since, unlike equipment, these assets are not held for use in a business or trade.
Retaining the Services of a Qualified Intermediary
A qualified intermediary (QI) is necessary for most exchanges in which the relinquished assets are sold to a buyer and the replacement assets are being acquired from a seller, who is not the same as the buyer of the relinquished assets. The taxpayer essentially sells the relinquished assets to the QI, who in turn sells them to the buyer. Similarly, the taxpayer purchases the replacement assets from the QI, who acquires those assets from the seller. In effect, the taxpayer completes an exchange with the QI. Selecting the correct QI is a decision that should not be taken lightly. Read on to learn more about the considerations for

Can Franchise Rights be Exchanged?
Since becoming law in 1921, the rationale for the inclusion of tax deferred exchanges in the IRS code, has been that a taxpayer who is vested with an asset and who receives in exchange other like-kind assets, and no cash, there is a continuity of holding the same or similar assets. Since the same kind of assets were sold and bought and the taxpayer pocketed no cash, the transaction isn’t seen as a taxable event. The gain on the sale of the first assets, the relinquished property , is deferred until the acquired like-kind assets, the replacement property , are sold without a further exchange.
Upon the passage of the Tax Cuts and Jobs Act (TCJA) in 2017, the types of assets qualifying for tax deferral through an exchange changed dramatically. Tax deferral through 1031 exchanges would only be allowed for what is considered real property (land, buildings, etc.) and not for personal property (heavy equipment, cars, franchises. Therefore, since the passage of the TCJA, the actual franchise rights no longer qualify for a like kind exchange to defer taxes on gains. However, should the investor own the underlying real property where the Franchise resides the investor still could qualify for an exchange on the underlying land/building.
What Qualifies for Tax Deferral upon the Sale of a Franchise?
Perhaps the most common inquiries around franchise exchanges are those that involve fast food restaurants. An owner might have one or more franchise locations that have greatly increased in value over time, value that the owner would like to parlay into additional restaurants. The exchange of such a business was formerly a more straightforward matter because the IRS regarded the business as a whole entity that included the value of any underlying assets. This changed shortly before 1991’s exchange regulations, and now the IRS requires that each underlying asset be separated and valued individually.
For owners/investors of franchises this means that the value of the franchise rights are separate from the value of land, buildings and furniture, fixtures and equipment (FF&E). A restaurant franchise valued at $300,000 for the franchise rights and $750,000 for the land/building can separate the sale of the land/building from the sale of the franchise rights. The land/building would then qualify for a like-kind exchange into land/building for a new franchise or a multitude of other real property deemed like-kind such as a multi-family rental building or farmland.
It’s worth noting that any value associated with goodwill, including trademarks and trade names, is not capable of being exchanged, because the regulations state that goodwill is “inherently unique and inseparable from the business.” For this reason, sellers of businesses may wish to minimize the value of the goodwill and increase another component asset of the sale which will be capable of receiving like-kind exchange treatment. Inventory and cash-on-hand are also not part of a franchise exchange since, unlike equipment, these assets are not held for use in a business or trade.
Retaining the Services of a Qualified Intermediary
A qualified intermediary (QI) is necessary for most exchanges in which the relinquished assets are sold to a buyer and the replacement assets are being acquired from a seller, who is not the same as the buyer of the relinquished assets. The taxpayer essentially sells the relinquished assets to the QI, who in turn sells them to the buyer. Similarly, the taxpayer purchases the replacement assets from the QI, who acquires those assets from the seller. In effect, the taxpayer completes an exchange with the QI. Selecting the correct QI is a decision that should not be taken lightly. Read on to learn more about the considerations for